South Africa could see significant currency depreciation during the second half of this year due to the increasingly risk-averse global investment climate and government recognition that the currency is overvalued, experts have suggested.
Africa’s largest economy has seen a sustained surge in capital inflows since early 2009, resulting in significant appreciation of the rand and prompting trade minister Rob Davies to suggest earlier this week that the currency was “overvalued”.
However, with mounting uncertainty in both Europe and the US and with investors believing that the value of the currency may have peaked, analysts now anticipate the currency to weaken, triggering a sharp reversal of investment flows during the second half of the year.
In addition, following Davies’ public admission that the currency was overvalued, there are growing signs the government may intensify efforts to purchase foreign reserves in a bid to suppress the value of the rand, as it bids to prioritize domestic job creation.
“We’ve seen a flood of money into South African equity and bond markets due to a strong carry trade since March 2009, and this has undermined attempts by the Treasury and Reserve Bank to accumulate more reserves to stem the currency’s strength,” said Michael Keenan, head of forex research at Standard Bank in Johannesburg.
“But we’re now seeing risk aversion starting to come back into the market, and investors don’t seem keen to buy the rand at these levels, so ongoing purchases from the central bank and the treasury should accelerate the currency weakening.”
Keenan added that while the strong rand had helped to absorb some of the impact of rising imported fuel and food prices, it had hampered the country’s manufacturing sector and contributed to unemployment by hastening mechanization, exacerbating the country’s 25%-plus unemployment rate.
“The strong rand has made it increasingly difficult for local exporters to compete, has hindered competitiveness and increased the propensity of manufacturers to mechanize the workforce, adding to South Africa’s high unemployment rate,” he said.
The government has recently signalled that its primary focus in on supporting the country’s manufacturing sector and creating jobs, adding to expectations that it will intensify efforts to weaken the value of the currency.
“We want to as a country boost our manufacturing capability, which will also have an impact on the job creation,” a government spokesman told Emerging Markets, adding: “The new emphasis is about jobs, jobs, jobs.”
Keenan’s base-case scenario is that the currency will weaken from current levels of around ZAR6.75 to the dollar to around ZAR7.30 by the end of this year and ZAR7.90 by the end of 2012.
However, while a weaker currency should benefit South African manufacturers and may have a positive short-term impact on growth, he warned that it may also exacerbate inflation concerns.
In addition, the possibility of sharp outflows could be extremely disruptive for the economy. “South Africa has seen massive speculative inflows and the rand is one of the higher-beta emerging market currencies, so if and when things do turn around, it could take the biggest knock and it could be a vicious uncoil,” he said.
Last month South African Reserve Bank Governor Gill Marcus described the rand as a "volatile currency" but declined to say whether she thought it was weak or strong.