A report by Old Mutual highlights that, despite the rand’s gains in the past few months, South Africa’s currency is at the mercy of inflation, which will undoubtedly change what your savings and investments will be worth a decade from now.
The rand made headlines this week, suffering one of its worst days in 2018 on Monday on the back of a stronger US dollar and poorly performing emerging markets.
Analysts forecast that the currency could weaken further and hit R12.75 by the end of the year, as the bulk of good news, including the appointment of a new president, had been priced into market already.
Thus the rand would probably take its direction from global factors in the near/mid-term.
Of course, not all opinions point south, with other analysts being notably more positive on the currency, arguing that stronger economic growth should prove supportive to the local currency – forecasting the rand to reach R11.50 by the end of the year.
According to Old Mutual, irrespective of the rand’s ups and downs, the one thing that will definitely affect its value in the longer term is inflation.
StatsSA reported earlier in April that the country’s inflation rate fell to a seven-year low in March, slowing to 3.8%. However, a rise in the VAT rate which kicked into effect at the start of the month is still expected to have an impact in the financial data being reported in the near-term.
Central bank Governor Lesetja Kganyago said last week that the economy has managed to reduce some of its key vulnerabilities such as the size of its current-account deficit as a share of the economy.
As a result, the bank has some “breathing space” should risks to the inflation outlook – such as currency movements or a spike in oil prices – come to fruition.
Citing Ronald Reagan in its latest long-term prospective report, Old Mutual noted that “inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man”.
Specifically it noted that many South African investors suffer from ‘inflation illusion’ as they fail to notice how destructive it can be over time.
To demonstrate this point, it published a graph of how inflation is expected to erode spending power in South Africa over the next 10 years.
At a 6% inflation rate, Old Mutual said that spending power of R10,000 effectively halves to R5,584 – while over 20 years the spending power drops down to R3,118, nearly a third of its value.
According to Old Mutual, it expects the average inflation rate to be 5.5% over the next five years, which is within the Reserve Bank’s target range of 3% to 6%.
“The risk, though, remains to the upside – despite our base case expectation that inflation could move in a 4.5% to 5% range for most of 2018,” it said.
The group said that investors and savers need to learn a lesson in looking at long term investment returns in “real” terms, stripping out the impact of inflation.
“As we are a small and an open economy, SA inflation will always be subject to big global cycles as the currency and, consequently, food and petrol prices play havoc with price changes. Exchange rate risk is particularly high, given how exposed SA is during this period of heightened political and ratings risk,” it said.