Unpacking the rand’s latest decline

JOHANNESBURG – The weekend slide in the rand has caused many to panic, with some analysts attributing it to South African failures, presidential inefficiencies and other local elements. The truth, however, is far more complex.

The first key element to note is that this is not confined to South Africa. Emerging markets as a whole have suffered severe blows due to the sell-off of riskier assets by investors, and there are many factors contributing to this sell-off.

The trade war

The trade war has played a key role in the global economic dynamic and the effect we have witnessed on emerging markets. Initially starting as a spat between China and the US, this is now a full-blown trade war filled with retaliation in terms of tariffs from countries across the globe. 

Turkey, a key player in the emerging market sector, is the latest target with US President Donald Trump doubling tariffs on Turkish steel and aluminium imports.

US President Donald Trump doubled tariffs on Turkish steel and aluminium imports. Photo: AP

Import tariffs and protectionist policies eliminate free trading environments and cause uncertainty sending investors scurrying to safe havens. But there is more to it than just the restriction on trade.

On Friday, Turkey experienced what could be classified as a currency bloodbath as the lira plummeted by more than 18 percent bringing its 2018 losses close to 40 percent. Turkey is now accusing countries – the US being the most obvious subject of discussion – of engaging in economic warfare on the country following a failed coup in 2016.

The Turkish picture is dire, with inflation close to 14 percent coupled with severe currency devaluations, there is little to appease investors as they rapidly exit the market

Why does the effect on Turkey matter?

While emerging markets all operate individually, they remain interconnected by classification, a sell-off in one emerging market spills over into other emerging market countries that offer liquidity, such as South Africa. So it is au revoir to emerging market currencies as this sell-off dumps currency back into the market, diminishing its demand and therefore the price.

Foreign interest rate hikes

We all owe something to someone, whether it is a lunch or a thank you note. It is no different in the market environment. Unfortunately in the financial markets this debt is expressed in billions of dollars, and an IOU simply will not suffice.

Looking at debt levels – Turkey owes about 70 percent of its gross domestic product (GDP) in dollar- and euro-denominated debt, South Africa owes about 40 percent and Russia about 30 percent – one can quickly grasp the impact of rising foreign interest rates, especially in the US and Europe. 

As these two regions move away from the quantitative easing state prevailing since the Global Financial Crisis and raise interest rates, foreign denominated loans become harder and harder to service, especially by economies under pressure.

Poor economic recovery

While the global economy has been able to shake off the economic turmoil and recover reasonably well from the economic crises, emerging markets have been lagging behind on the journey to stability. Turkey, South Africa and Brazil have all been victims of slow economic growth, rising government debt and poverty.

China slows production

A slowdown in manufacturing in China – a result of the trade wars and China’s move from a being producing economy to a consuming economy – has impacted on emerging markets that rely on trade between the two economies.

As China consumes more than 50 percent of the world’s hard commodities, one can see how a commodity driven country such as South Africa can feel the pinch when this number starts to decline. 

Over the past two years a slowdown in economic growth in China, coupled with a deceleration in production gradually, inexorably cuts off the oxygen to commodity-driven markets. Without a back-up plan in place, the resource producers are left stranded.

Being part of a system

So while local dynamics certainly impacts on the rand, it is important to understand the global backdrop and see the market for what it is: interconnected. What one country decides, creates ripples to the next and so the global market dynamic continues.

Emerging markets – being the riskier element – unfortunately bear the brunt as investors seek to protect their investments.

As an emerging market currency and being in a highly liquid and efficient market, the rand is unfortunately bundled with the rest of the emerging market grouping. So while the rand slipped more than 4 percent, it is important to view this in relation to our peers.

Luckily investors are also risk seekers and eventually, once the storm has passed, they will once again yearn for the yield of an emerging market, as long as the associated risk is aligned with the reward.

Bianca Botes is corporate treasury manager at Peregrine Treasury Solutions.

The views expressed here are not necessarily those of Independent Media.

– BUSINESS REPORT