By Cees Bruggemans, Chief Economist FNB
During August our gross foreign reserves jumped by $2bn to $38bn even as the Rand firmed through 7.70:$.
Yet the reserve gain wasn’t due to SARB forex accumulation.
Instead, the reserve gain was all bookkeeping, mainly getting SDR 1.4bn from the IMF (dishing out $250bn of new drawing rights to 186 countries in terms of decisions earlier this year to bolster global foreign reserves). There was also a minor revaluation in our gold holdings, with gold at $942.
For September we face yet more of the same, with the Rand approaching 7.40:$, another $300 million forthcoming from the IMF, some $500 million injected by the latest government foreign bond issue and gold currently trading over $1000.
That could push gross foreign reserves through $39bn by month end without a single Dollar purchased by SARB aiming to moderate the Rand advance.
But then one would be confusing too many things.
The reserves are currently only boosted by gratuitous events (IMF issuances, gold price).
The SARB officially does not try to influence the Rand (ever since 1998 being fearful of reaping whirlwinds), besides which Treasury may currently be uninterested in bankrolling any sterilization attempt.
Treasury is presently budget deficit preoccupied. If it doesn’t want to increase the national debt by issuing more government bonds for the purpose of being sold by the SARB to neutralize the additional liquidity created when printing Rand to buy Dollars for its closely-held harem (the foreign reserves), SARB has no other choice but watch while the Rand firms steadily.
Indeed, Treasury may well prefer ‘unsterilised’ Rand interventions, SARB accumulating Dollars while increased liquidity pushes market interest rates lower, presumably just what the economy needs.
Under current global conditions, driven by low interest rates near zero and risk appetite rebounding as money leaves low return safe havens for booming bond and equity markets, it means renewed capital inflows for us approaching windfall conditions.
The Rand firms as a consequence. Heaven only knows how long this will last (long, according to Bernanke and King, to which Trichet will add his concurrence, if somewhat differently phrased). And who knows how firm and overvalued the Rand could get as a consequence.
In 2005, with the SARB leaning into the wind (at the time able and willing to accumulate Dollars, though not meant to intervene with the Rand), the Rand got to 5.60:$ while fair value was closer to 6.50-7:$.
In other words, the Rand got to be 15%-20% overvalued at the peak before the rising current account deficit, the moderating capital inflow and SARB Dollar purchases finally turned the tide (very gradually) during 2006-2007 (and shock events during 2008 pushed the Rand near 12:$).
So, Amigo, what prospects does this grant us today?
We have a shrinking current account deficit of about 3% of GDP, from which we still have to deduct our foreign aid (Custom Union payments, Rand-Denominated). This leaves an external payments deficit of barely 1% of GDP. And no SARB Dollar purchases of any note so far.
This profile further inflames foreign interest for our corporate assets, bonds and equities, creating a hotrod currency.
That’s today’s reality, and something we may see through 2010 and possibly beyond.
With Rand fair value today residing near 7.50-8.00:$ (our cumulative inflation differential since 2006 has been rather heavy), a 20% overvaluation would see the Rand in 6.00-6.50:$ territory. A 30%-35% overvaluation would see us exploring 5.00-5.50:$ territory.
As before, such Rand overvaluation episodes would eat into our exports. Thus GDP growth would suffer even as inflation gets suppressed.
We then patiently wait for the end.
World conditions eventually turn, with global interest rates rising again, but that would initially be at most a normalizing condition. Asset markets aren’t supposed to become intimidated by monetary policy merely normalizing.
Global risk appetite could well keep going, if more modestly, through such eventual normalization. Besides, there will still be the pull from Asian growth and push from its expanding liquidity.
Our foreign capital invasion may well eventually crest, but it needn’t pull back early or quickly. Instead, the early reaction will presumably be from our exports and imports as the current account deficit starts to widen again, requiring more Dollar funding. But with a slow coach economy at home, greater external absorption could take a long time to fully materialize.
A roundabout way of saying that another bout of Rand overvaluation could go FURTHER and potentially last LONGER than last time (2003-2006).
The flipside of all this may be that few of us really fully appreciate where all that could park our interest rates for the duration.
Prime rate is currently 10.5%. That may be too high for what is conceivable coming at us from the outside via the firming Rand.
Winners and losers change places speedily in our country. Last year weak Rand and high prime. Next year the very opposite could again prevail.
Source: Cees Bruggemans, FNB, September 14, 2009.
