Banking on the Rand

South Africa appears to have achieved what must have seemed like a pipe dream just a few years ago - a stable currency.



Not everyone is happy, however, with manufacturers complaining that a stronger rand is making them uncompetitive. The government too now views the strong currency as hurting its attempts to broaden the base of the economy, but remains unlikely to change its monetary policy tack.



Recently, the rand seems to have found a range between 6 and 6.50 to the US dollar, falling from nearly R12 to the dollar five years ago.



South African exporters, from wine producers to manufacturers of textiles, have thus been praying for the rand to soften, but it increasingly seems they will have to look for other ways to remain competitive.



Elsewhere, things have never looked better. Under the guiding hand of the erstwhile minister of finance, Trevor Manuel, South Africa is now enjoying its best macroeconomic position in 40 years.



The hard austerity measures embodied by the deceptively named Growth Employment and Redistribution Act (GEAR) are now paying dividends, having fostered market confidence in the ANC to run the economy responsibly.



The GDP to debt ratio has been substantially reduced, falling from above 50% of GDP to below 35% in the last five years. Inflation is relatively low at 4.2%, well within the government's target of between 3 and 6%, while economic growth topped 5% in 2005.



Foreign reserves have also grown to $14.9bn, with South Africa now becoming a small net creditor. The government predicts the budget deficit will be 1.6% of GDP in 2006, while most analysts predict that it will be closer to 0.5%. Many analysts believe the government may be talking up the size of the deficit in order to head off those on the left of the ruling African National Congress (ANC) calling for an increase in welfare spending.



Forex controls are also being phased out, with the personal offshore allowance being increased from R750,000 ($122,000) to R2m ($325,000) in the January budget.



Meanwhile, the stronger rand has caused a dramatic retreat on the current account, with the deficit reaching 5% of GDP in 2005, as South Africans indulged a taste for foreign luxury items.



This has been offset by a massive boost in investment. By all accounts, foreign direct investment (FDI) is expected to be well over R100bn ($16.29bn) for 2005, proving it to have been a record year.



At the same time, Standard & Poor's Ratings Services announced this month that it has assigned its BBB+ senior unsecured debt rating to the upcoming benchmark euro-denominated bond issued by the Republic of South Africa (foreign currency BBB+/Stable/A-2; local currency, A+/Stable/A-1).



Macroeconomic stability has certainly been a major factor in the strengthening of the rand. The main driver of the rand remains commodity prices, particularly gold, with South Africa the world's biggest producer of the metal. Some analysts predict gold could reach $600 an ounce in 2006, more than double where it was at the turn of the century. This is being driven by the combined effect of growth in China and India.



Steven Shepherd, senior precious metals analyst at JP Morgan, thinks precious metals could have a long way to go yet.



"China is one of the biggest markets in the world for platinum and India is the biggest market for gold and we believe that China also has huge potential for gold. Demand for gold in China has lagged far behind other commodities and we feel that this is going to be a huge demand segment in the future and it is one of the reasons we feel the gold segment is fundamentally bullish", he recently told OBG.



It is generally agreed that as long as commodities remain bullish there will be little respite for manufacturers.



Justin Barnes, managing director of B&M Analysts, told OBG that South Africa is a victim of its minerals and energy complex.



"Every morning I look at the gold price and the rand and you can see it, gold strengthens and the rand strengthens. That may be wonderful for the consumer, but it is lousy for the manufacturer who has to contend with a stronger rand."



The difficulties faced by the clothing and textile industries have been compounded by the value of the currency, with the two industries shedding 10% of their workforce in the last 12 months.



Help for manufacturers, however, has been thin on the ground, with the government bringing about a phased reduction of support for industries such as textiles and automotive industries. This is being supplanted with capital investment support and a massive boost in infrastructure spending, which will total R370bn ($60.26bn) over the medium term. This, it is hoped, will create conditions that will enable the economy to grow beyond 6% annually.



Yet despite South Africa's impressive record of macroeconomic stability, there remain several threats to the stability of the rand. While South Africa's ratings continue to improve, the latest Lehman Brothers "Damocles" report rates South Africa as second only to Turkey on a list of emerging markets most likely to suffer from a currency crisis.



Analysts still view the currency as being overexposed to commodities. One such fear concerns the possibility of gold reaching a price where it becomes attractive for reserve banks to sell gold. The widening current account deficit remains a concern too, as does the nature of FDI flows into South Africa at this time, with much of this speculative capital searching out interest rate differentials. Also, foreign exchange reserves, while growing substantially in the last year, are still not equal to three months' worth of imports.



Nevertheless, with South Africa's sound fiscal management, the currency will surely be better able to absorb market shocks than at any time in recent history.