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What a strong rand means

Local economic update: November 2010


By Tendani Mantshimuli, consumer economist, Liberty Life

What a strong currency means to the South African economy

The most topical economic issue of the last few weeks was the strength of the rand against the US dollar
and other currencies of our trading partners. In this article, we look at what this means for our local
economy.

Impact on manufacturing
A strong rand hurts the local manufacturing sector because exported goods become more expensive while
imported goods become cheaper: in both cases, the price of local goods is less competitive. As
manufacturing contributes about 15% of gross domestic product (GDP) and a significant number of
employment opportunities, the manufacturing sector’s performance is important to the economy.

However, low export performance cannot be attributed to the exchange rate alone. Low economic growth in
our trading partners, in particular Europe, our major trading partner, has also played a role. Until we see a
sustained economic recovery and improved consumer demand in our trading partners, the performance of
the local manufacturing sector will remain vulnerable. While there’s not much argument that the strong rand
has been a setback to export-oriented sectors of the economy, it would be wrong for the manufacturing
sector to rely on a weak rand for its competitiveness.

Mining industry affected


The other sector of the economy affected by the strong rand is the mining sector. There’s been a strong
increase in commodity prices and the gold price has risen to historically high levels. However, South African
mining companies have not been able to take advantage of this due to the strength of the rand.

There is an upside
Having said this, there are some benefits to the economy from a strong currency. The strong rand has been
beneficial to inflation, as the cost of importing goods remains very low. Low inflation means that interest
rates can remain low for longer, which benefits consumers and particularly the poor, as it preserves saving
and spending power. Low interest rates and low inflation are beneficial to consumers who remain extremely
indebted with household debt as a percentage of GDP at 78.2% in Q2 2010.
Though the probability is low, there’s room for the Reserve Bank to cut rates further at the last meeting of
the year to support the fragile economic growth. The Reserve Bank’s leading indicator of economic growth
has declined modestly, indicating weak growth ahead.

What to do about the rand


This is not a uniquely South African problem; all emerging markets are going through the same thing as
money flows into these economies’ bond markets seeking higher yields. It seems as if investors feel that
the higher return offered in emerging economies outweighs the risks usually associated with these markets.

The SARB and Treasury are also concerned about the strength of the rand; the challenge is what to do
about it. For South Africa, direct intervention might be too expensive. According to the Governor of the
Reserve Bank, they are assessing the effectiveness and appropriateness of measures taken by other
countries and will then decide on measures that South Africa can take, if any.

Medium Term Budget Policy Statement


In his Medium Term Budget Statement Finance Minister Gordhan said government would give the SARB
funds to accumulate reserves so that the bank can see ‘whether there are opportunities to stop it from
appreciating further.’ Exchange controls have also been further relaxed allowing South Africans to take out
R4 million out of the country a year, opening up, for example, investment opportunities abroad for those who
can afford to. In further good news to the economy he also announced an upward revision for GDP growth
from an earlier conservative estimate of 2.3% to 3% for 2010. Inflation is also forecast to remain quite low
for longer which means low interest rates as well. Government finances are also looking healthier as tax
revenue has improved since the Minister’s budget speech in February. Government’s continued
commitment to fiscal discipline is good news for the economy and supports the efforts of the SARB in
making the country an attractive investment destination.

Liberty Group is an Authorised Financial Services Provider in terms of the FAIS Act (Licence no. 2409). The
information contained in this communication, including attachments, is not to be construed as advice in
terms of the Financial Advisory and Intermediary Services Act of 2002 ("FAIS") as the writer is neither an
appointed representative of Liberty, nor a licensed financial services provider as contemplated in FAIS.
Please consult your financial adviser should you require advice of a financial nature and/or intermediary
services.

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