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Rand's fate unlikely to mirror current face of dollar

Rand's fate unlikely to mirror current face of dollar < News < Bet On Markets

Are there similarities between the current behaviour of the rand and that of the dollar 10 years ago?

Since the past decade or so, the US has enjoyed both a strong domestic economy and currency against its major counterparts. There are a few reasons that could be ascribed to the continued strength of that economy, ranging from a strong consumer base or spending in a declining interest rate environment as a driver of corporate earnings, to productivity gains.

The South African economy, as evidenced by the latest gross domestic product data and a sleuth of extraordinary earnings reports from domestic companies, is currently buoyant, fuelled by consumer spending following a spate of interest rate cuts over the past 12 months. There is nothing untoward about this cause and effect. It’s unlikely authorities will tolerate an uncontrollable twin-deficit scenario.

The US dollar, also over a decade, has maintained its relative strength away from pure fundamentals from those of its trading partners. It can now also be said that the rand is also «punching above its weight» against our trade partners, with some of the reasons initially behind the rand strength and interest rate differentials having lost relevance.

Even though there are similar trends between the two economies and currencies, given the mismatch in timing, looking into 2005 and beyond, one can not help but worry that the «party will end soon», as is currently the feeling among market commentators about the US economy and specifically the dollar. Especially given the fact that over the past decade, the US trade and current accounts have been financed by foreign portfolio flows especially into their treasuries market by the Chinese and Japanese authorities, and a fair share of global foreign direct investment.

South Africa is currently building up a sizeable trade deficit as a result of cheap imports on the back of a stronger currency.

Soon, the trade deficit will result in a sizeable current account deficit, and like the US, both economies have historically, but for differing reasons, low domestic savings levels. In addition, like the US, our «twin» deficits have up to now been financed by «hot money» in the form of investment portfolio flows in the absence of any notable foreign direct investment.

Given these similarities, it is plausible that there be structural road bumps ahead for the rand. But there are two critical reasons we do not believe that the eventual outcome for the rand will be the same as what the US dollar is currently going through — that is, significant turn in sentiment.

One is that it is very unlikely that the South African authorities will tolerate an uncontrollable twin-deficit scenario, at least we have no major wars to finance! Second, and most importantly, given the government intended infrastructure spend, there ought to be sufficient domestic fixed investment to justify the continued economic and rand strength.

For the South African economy and currency though, the momentum is certainly on our side. But we need all the ingredients to come through: the Absa/Barclays deal; the R150 billion planned state spending; 2010 and Gautrain must get off the ground; and there is nothing wrong with a further rate cut to ease debt burdens and encourage consumption.

By Patrick Mathidi

Patrick Mathidi is the deputy managing director of Andisa Securities.

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