Despite the fact that trade in actual goods and services only account for a fraction of rand turnover, the current account may still have a certain impact on the rand exchange rate. As I explained in a previous post, the consistent trade deficit of South Africa requires a consistent appetite for rands by foreigners for the currency to keep its strength. A trade deficit means that South Africans must purchase foreign currency (paid for in rands) in order to pay for these foreign goods. However, we can only purchase foreign currency if there are foreigners out there willing to sell it in return for rands. If the rand is too expensive (strong) for foreigners to find it worth purchasing, we have two choices: (1) Either we consume less foreign goods and let the trade deficit narrow, or (2) we accept to pay more rands per foreign currency so we can maintain our consumption level of foreign goods. Because our consumption and production is slow to respond to price changes, it seems likely that the latter option will occur in the short run. To quote my blog post from 6th December:
My prediction is that South Africa’s trade balance will remain unchanged in Q4, but demand for South African assets (and indirectly the rand) will fall short of current account deficit at the current exchange rate. This will require a further rand depreciation to allow South African’s to maintain their current consumption level. Given the low growth rate in Q3, one may have reason to hope that the Bank does not respond to rand induced inflation pressure by raising rates.
This is exactly how events played out. Inflation came in slightly higher than previous months, and despite this the repo rate was announced at yesterday’s MPC press conference to remain unchanged. The trade deficit for Q4 is still unknown, but is expected to be at least as high as Q3 due to seasonal consumption, low mining output, etc. With little change in the appetite for rand this may have caused the strong depreciation to 9 rands to the dollar. In her MPC statement, SARB governor Gill Marcus stated that:
The exchange rate has been impacted by the widening deficit on the current account of the balance of payments during 2012 and changing global and domestic risk perceptions, particularly relating to the adverse developments in the South African labour market, and the downgrades by the various ratings agencies.
These are all good points, but the labour unrest and rating downgrades should have been priced into the rand exchange rate for a while already. In addition, with the VIX being at record lows, global risk perceptions do not seem to explain this recent depreciation any better. Ms Markus also points out in her statement that non-residents already own a third of South African government debt and may simply be hesitant to purchase more of it. Non-resident net purchases of SA government bonds are still positive but much lower than their record high in June 2012. It may be that the government’s consistent budget deficit combined with the SA consumer’s continued appetite for imported goods is the true cause of this weakness. However, while I in december expected a further depreciation of the rand, I am now inclined to think the risk is to the upside (for a stronger rand). Despite low net purchases of SA bonds by non-residents, they did rapidly increase their purchases of South African equities. This may be caused by the reduced global risk premia as can be seen in the low VIX. With continued easy monetary policy in the US, Europe and now Japan, the rand should be well placed to start attracting more foreigners to SA debt and equity.