How political decisions hit your currency
19 September 2016
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On mobile, on digital, on demand, this is Old Mutual Live Money Coach. Hello and welcome, my name is Chris Gibbons. Once again the South African Rand has taken a bashing and once again it seems to have something to do with politics. I thought it would be interesting to explore how that relationship works, what the mechanisms are, if you like and what the weaker rand means for ordinary people.
Joining us now from Cape Town is Old Mutual Strategist, Izak Odendaal. Izak, welcome, thanks for your time. First off, let me make it clear that I’m not looking for a political judgment from you. We all have views, they can be very divergent. But why when the politicians start shouting at each other, why does the rand react?
Izak Odendaal: A couple of things to bear in mind here. Every day millions of investment decisions are made around the world. These decisions are made with some kind of assumption of what the future looks like. If you’re buying an asset, you have some sort of idea of what the future is going to look like.
Then one day you open a newspaper and you read news and this changes your perception of what the future looks like. Specifically, in this instance I think there’s a concern that without a strong finance minister, government finance is over the longer term, could possibly deteriorate. Investors therefore are less likely to want to hold South African assets and therefore the Rand goes down.
Bear in mind that typically, as I said, millions of investment decisions are made every day. Often investors shoot first and ask questions later. So there’s typically a knee-jerk reaction to any kind of bad news. Given that the Rand is such a highly traded currency, it almost always happens.
How the Rand has fluctuated since December
CG: In this case the Rand has fallen, as we know. But nowhere near as far as it went when President Zuma sacked his Finance Minister.
IO: Yes, so the interesting thing is, as of Friday morning, the Rand is actually pretty much where it was a month ago. So the interesting thing from investors, it depends what your starting point is. Yes, the Rand has weakened from where it was earlier during the month of August.
But the Rand is still where it was during July and is much stronger than where it was in June or in May and as you said, back in December 2015. The Rand actually fell towards R16 to the dollar. What’s changed between December and now is that the global climate has really shifted.
Back in December we were in the midst of a global sell-off in emerging market assets, so it wasn’t just our currency. It was also the likes of Brazil, Turkey, Russia and so on. It saw their currencies collapse. The December firing of Finance Minister really happened against the very unfavourable backdrop.
That backdrop has improved significantly since the start of the year. Global interest rate expectations have come down significantly and emerging market assets, including the Rand, have rallied. Fortunately for us, at least this time around, the global backdrop is a little bit more favourable.
CG: Izak, this kind of thing happens in other countries as well doesn’t it? I’m thinking about the British Pound after the vote to leave the European Union.
IO: Yes, the Pound fell very sharply after that Brexit vote. Globally there’s been a lot of political shenanigans. We think to the recent coup attempt in Turkey, you think that in Brazil the President Rousseff is facing impeachment in the senate at the moment. Politics is messy everywhere. As I said, in the short term, these kind of events really drive markets as investors over-react. In the long term, if you take a long term view, these kind of events tend to be rather meaningless.
CG: Is it fair to say then that the price attached to your currency is in some measure a reflection of how other countries and other investors view you? Like your countries share price in a way?
IO: It is and it isn’t. It is in the sense that yes, it obviously reflects good news and bad news in the economy. We saw for instance after the elections, that the rand rallied. Global investors were quite happy with what they saw, South Africa being a stable democracy, freedom of speech. Parties accepting where they lost, parties that won, winning graciously and so on. But it’s not always the case that a strong currency is good for your economy.
If you take the case of the UK for instance, you mentioned earlier, when the Pound fell, or as the Pound fell. UK share prices actually increased. The FTSE 100 today is much higher than it was before Brexit. That’s because those companies benefit from a weak Pound because they all export and they’re all multi-nationals.
Similarly, we saw the JSE actually rallied over the last few days as the Rand weakened. Because the big Rand hedge shares of the JSE have done quite well. A weak currency or a strong currency creates winners and losers, in both directions.
How it hits home for the average person
CG: What then are the ways that ordinary people would feel a weak rand?
IO: For ordinary people, for all of us really, the weak Rand means that the stuff that we import becomes more expensive. The main item there is obviously oil. Because we don’t have our own oil, so we have to import oil to drive our motor cars. Again, there it matters what the global oil price is. If the global oil price is falling, then the weak Rand doesn’t hurt you as much.
We’ve seen in the last couple of weeks the oil price actually recovering back to about $50 a barrel and therefore the weak Rand will probably then translate into a petrol price increase at some stage in the next month or two. Again, the Rand is quite a bit stronger than where it was at the beginning of the year.
CG: You’re listening to Old Mutual Live, the Money Coach edition, on demand, visit dogreatthings.co.za. On the other hand Izak, exporters like a weak Rand, so isn’t that good for jobs?
IO: Again, as I said earlier, when the currency moves, it creates winners and losers. Exporting firms like a weak Rand. Firms that compete with imports like a weak Rand. Obviously the tourism industry likes a weak Rand. So there are definitely benefits to the economy. There are also benefits to investors.
If you invest in a typical balance fund, a portion of that balance fund will be invested in global shares, in global bonds, global property. Those things become more valuable as the currency depreciates. Investors can also benefit from a weak Rand. That’s why we always say, we always talk about the importance of being diversified. So that your portfolio and your investments and your assets are not that directly affected should the Rand weaken or strengthen. There are certain people who benefit from a weaker Rand, it’s not all bad news.
The impact of a ‘ratings downgrade’
CG: Final question, we also hear that the politics and the weak Rand could lead towards something called a ‘ratings downgrade’, what does that mean in layman’s terms. Once again, how would a ratings downgrade affect ordinary South Africans?
IO: The ratings downgrade or a credit rating is really a reflection of the government’s creditworthiness. The government borrows huge amounts of money every year and the credit rating agencies assign a rating that reflects how creditworthy the government is. How likely the government is to repay the money that it’s borrowed.
The events of the last week or so really do, I think, increase the likelihood or the risk of a downgrade later this year. We saw that in May and June, the ratings agencies did not change our credit ratings. I think this makes it slightly more likely, but it’s not necessarily going to happen.
The impact of a ratings agency change or a credit downgrade is potentially on the borrowing cost of the government. Just to get slightly technical, the government issues bonds, that’s how it borrows and it pays interest. Those bonds are traded in the market and the yield on those bonds move up and down.
n other words, the cost of borrowing moves up and down. Just in the last week the cost of borrowing, for the next 10 years for the South African government jumped by 50 basis points, by half a percent. The market is already reflecting our higher cost of borrowing for the South African government and to a large extent, it already anticipates a downgrade.
What the impact will be for ordinary South Africans, if there is a downgrade. I’m saying it’s an ‘if’ and not a ‘when’. Is potentially it means that government borrowing costs remain higher over the long term. Potentially that means that they might have to increase taxes to fund finances. It’s not necessarily going to be something that has a huge impact on your portfolio, if you are an investor.
CG: And there we’ll leave it. This has been another edition of Old Mutual Live Money Coach, my name is Chris Gibbons. With me on the line from Cape Town has been Old Mutual Strategist, Izak Odendaal. Remember, please feel free to get in touch any time if you have any questions for me, topics you’d like covered on Old Mutual Live Money Coach. Feel free to send them direct to me at email@example.com, I’d be delighted to hear from you. Until the next time, thank you for listening. Old Mutual Live, on mobile, on digital, on demand.