While the day-to-day changes in the value of the rand may seem volatile, research from AlphaWealth shows that, over time, depreciation has been pretty consistent.
Andrew Flavell, wealth manager at AlphaWealth, has tracked the rand’s exhange rates between January 1997 and 2015 and compared its depreciation to two economic indicators, namely the inflation and interest rate differentials.
In 1997, the rand was trading at R4.39 to the dollar and R11.78 to the dollar at the time of Flavell’s calcualtions – a depreciation rate that averaged 5.3% per year.
Since 1997 South Africa’s inflation has averaged 6%. The US inflation has been 2.25% which makes the average differential over the period 3.78%.
According to this theory, the Rand should depreciate at 3.78% annually.
Looking at the interest rate differential, using the ten year bond yield, South Africa has on average been borrowing at 10.1% and the US has been borrowing at 4.05% which means the Rand should have depreciated around 6% to the US dollar each year.
“So the value of the rand should at R9.27 based on the inflation differential and at R13.74 according to the interest rate differential,” Flavell said.
“When we combine the two, the average differential of inflation and the interest rate, the average annual depreciation should be 4.9%. So the Rand should currently be R11.50 but it is currently trading around R11.78 which is only a 2.4% discount.”
Making up the gap
According to Flavell, the discrepency between the real depreciation rate and the theoretical one can be explained by other market influences such as:
- Capital flows: “Foreigners were buying South African bonds and equities since 2003. This peaked in 2011 and since then, foreigners have been net sellers of South African equities and bonds.”
- Market sentiment: “Business confidence is low due to power, labour and policy uncertainty.”
- Poor fundamentals in the local economy: “South Africa’s GDP growth has lagged behind its peers.”
- Low productivity: “Ideally a country’s output should be 50% or above. South Africa is currently around 45% which indicates weakness in output production.”
- Credit outlook: “With an unreliable power supply, the imminent ‘strike season’ and widespread corruption, the GDP growth rate may continue to come under pressure.”
According to Flavell, while the rand is currently trading at 2.4% discount, it may be a good idea to take investments offshore.
“Factor in the five reasons for the decline of the currency. If you believe that these issues will be resolved or turned around, then it may not make sense for you to transfer your investments offshore.”
“If, on the other hand, you believe that capital flows are more likely to exit rather than enter the country, that market sentiment will remain depressed, that GDP growth is unlikely, that productivity will remain low – now would be a good time to discuss these issues with your wealth manager and to evaluate offshore investment opportunities,” he said.