The rand should be closer to R15 to the dollar – here’s why it’s not

The South African rand is undervalued by as much as R3.00, says Investec chief economist Annabel Bishop – and this “substantial weakness” is one of the biggest contributing factors to higher food and fuel prices in the country.

According to Bishop, the rand’s fair value – tied to purchasing power parity – is closer to R15.50 than the current exchange rate of R18.70 to the dollar. Were the rand stronger, South Africa would see much lower petrol and diesel prices and lower inflationary pressure.

This would, in turn, push the South African Reserve Bank to ease off on interest rates.

Bishop noted that the rand has generally been weakened by the higher US interest rate environment since 2022, as well as severe risk-off market sentiment since 2020.

Local factors, including the sharp elevation of government borrowing, have added to this risk-off sentiment materially, she said.

With the 2024 Budget taking place next month (February), an update on government expenditure and revenue collection will be given, along with debt projections – but the budget deficit has already widened notably over 2023, the economist said.

“While main budget figures are not consolidated, the deficit to date for 2023/24 is already over R300 billion, at R312 billion – while the revised deficit for the full fiscal year is projected at R347 billion. This has widened substantially from (a deficit of) R247 billion in 2022/23,” Bishop said.

Gross loan debt is projected at 74.7% of GDP for 2023/24, well up from 70.9% of GDP in 2022/2023, and the 72.2% of GDP originally projected for GDP in 2023/24.

“This lift in projected borrowings has caused market concern and weakened yields,” she said.

Adding salt to the wound, South Africa has not benefited substantially from the prospect of US interest rate cuts compared to other emerging market economies, with the rand ending 2023 as the fourth worst-performing EM currency year on year after Russia, Argentina and Turkey.

“The deterioration of South Africa’s fiscal health provided some disincentive to foreign investment into SA government debt, which usually strengthens markedly on expectations of US rate cuts. A weaker rand remains a key risk to the country’s inflation this year,” Bishop said.

South Africa’s inflation rate is expected to average 4.5% in 2024, with an elevation expected in the early months, and a sub-4% rate expected later in the year due to base effects.

However, Bishop said that the weaker rand is one of the biggest risks to this outlook – and this could keep interest rates higher for longer.

“Given the marked weakness in the rand, which has contributed significantly to higher inflation, South Africa’s Monetary Policy Committee would likely favourably view rand strength in order to drive inflation lower,” Bishop said.

If the US cuts interest rates in the first half of the year – with March currently viewed as the first month this could likely occur, Bishop noted – the rand could see some strength as the differential between US and SA Bank rates widens if the Reserve Bank does not cut.

Bishop said that, while inflationary pressures – both globally and locally – are on a downward trend, this does not mean that interest rates will be coming down consistently, just that they are expected to come down over time.

Economists anticipate rate cuts in South Africa sometime in the second half of the year.

Other risk factors present for the inflation and interest rate outlook include the El Nino weather patterns, which risk pushing up food price inflation (which remains a risk for 2024), as well as higher global commodity prices, which could push fuel prices higher this year.

Read: Early blow to the rand