Expect more volatility from the rand in 2023

Rand volatility is the gift that keeps on giving to speculators and traders. Over the past year, from peak to trough, the ZAR-USD (rand-US dollar) rate swung 37%.

That might be a gift to speculators, but it can be fatal to businesses trying to do business without hedging forex exposures.

The big lesson learned by corporate treasurers and forex traders over the last two years in the aftermath of the Covid crisis was that the rand is able to take devastating punishment and still survive, says Chris Paizis, head of corporate forex and international banking at Absa.

“During Covid, forex performed admirably, showing that we’ve learned to live with crisis – it’s become a constant in forex,” he says.

Other countries in Africa, notably Nigeria, faced a severe shortage of US dollars as depreciation in the local currencies led to huge demand for US dollars. South African forex markets weathered the storms due to their deep liquidity. No sooner had the country emerged from the Covid crisis than the world was plunged into yet another economic crisis, this time triggered by the Russia-Ukraine war.

“We’ve lived through several years of extreme volatility in emerging market (EM) currencies, and the rand was at the forefront of that. The rand took a lot of hits and remained volatile throughout 2022, and we see more such volatility in 2023,” says Paizis.

“If I was corporate treasurer, one of biggest concerns I would have is having sufficient cash flow during a crisis and being able to make payments. A lesson learned during the last two years was the need for companies to develop a forex hedging policy – and stick to it.”

Importers who ran uncovered forex positions in 2022 were left to the mercies of a brutal and volatile market. A weaker rand benefits exporters, but even here there is the danger of volatility.

The way to avoid these risks is by formulating a forex hedging strategy, a process that starts by analysing and quantifying forex risks.

Companies with little forex exposure may have little need for such a policy, but even then contingencies should be put in place in case a large cross-border deal is signed.

Some companies will hedge forex transactions above a certain size, and those involved in dealings in multiple currencies will be able to offset some risks against each other, creating what is called a natural hedge. In such cases, they will attempt to hedge only the net exposure, and avoid over-hedging and incurring unnecessary expenditure.

Why currency risks will remain alive in 2023

It’s been nearly a year since the launch of the Ukraine war, which sent energy prices into orbit. Oil prices have moderated since the start of the war, but the impact for South Africans has been most visible in the ZAR-USD exchange rate, at the petrol pump, and in food prices.

Those risks will remain very much alive in 2023, says Paizis, as an end to the war is not yet in sight, and there is a general flight from EM risks.

“SA has its own internal factors like load shedding, infrastructure decline, political uncertainty, and the news on Friday [24 February] that it has been greylisted. A lot of these risks are unique to SA, and there will be a lot of focus on internal factors for the foreseeable future. That’s in addition to the external factors that are at play, such as the war in Ukraine, and widening geopolitical tensions involving China, Taiwan and the US, and of course North Korea.

“Risk aversion is going to be one of the dominant themes of the year, and we expect to see the rand as a traded ‘barometer’ once again for emerging market currencies.”

China’s late emergence from its zero-Covid policies had a global impact, the consequences of which are still filtering through the world economy. EMs are facing difficulties like supply shortages, which further fuel imported inflation. That, in turn, is hurting EM currencies and raising risk levels for companies.

Hedging strategies

Hedging strategies vary from company to company, but there are some universal basics to consider.

First of all, having a hedging policy and sticking to it. “For example, your policy might be to hedge only those risks 12 months out, and then to cover only 60% of the risks. These policies, whatever they are, were no doubt developed for good reason, and should not be violated,” says Paizis.

At the one extreme, a company may not hedge any risks, and at the other, hedge everything. There is a balance between these two extremes.

The tools used to hedge include taking out forward cover, forex options as well as more structured solutions.

What risks should clients keep top of mind in the current FX environment?

The big risks are in the field of logistics, from ports to transport infrastructure, and load shedding, adds Paizis. “There are also sector-specific issues, such as new trade barriers on citrus exports to the EU. If you add volatility to that, that’s an added risk. Companies are having to navigate multiple risks, not just exchange rates.”

What opportunities are there for clients in the FX space?

“Volatility presents opportunities,” says Paizis.

“A weak rand is good for exporters and it creates opportunities for import substitution. Something that becomes too expensive to import can then be made locally at a more competitive price.

“These are very turbulent times for corporate treasurers. They need expert advice on strategies to reduce forex risk, and we can help with that.

“In SA we have the benefit of deep liquidity, which means we can get access to sufficient amounts of US dollars or whatever currency is required for hedging.”

This is different to other African markets where currency liquidity is a real issue. Paizis says staying close to your core banks (such as Absa) is key in obtaining hard currency, given the structural scarcity that exists.

The events of the last two to three years have battle-tested a generation of young traders who had previously never seen a crisis of the Covid 2020 magnitude.

“The lack of hard currency across the continent will also be a major theme to watch this year,” adds Paizis.

Brought to you by Absa.

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