Why a weak Rand can hurt the weak

Many-handed Economists
Economists are wont to say “on the one hand this… on the other hand that…”. What they are trying to is to hold different variables in tension with each other, as economics seldom involves only two variables. A weak Rand will boost the profits of the companies which derive income from overseas, as they will get more for their dollars or other currencies when they convert their foreign currency into Rand. Many companies, betting on a steady decline in the Rand, diversified overseas, to take advantage of this expectation. When the Rand strengthened, their profits fell and many had to reduce their staff complements. This obviously hurt the weak. When the Rand strengthened, export earnings fell, but imported goods, including oil, became cheaper.

Inflation
It is clear that the Reserve Bank is scared of high inflation. If the Rand weakens, the price of oil in Rand will rise, even if the Dollar price of oil remains the same. The oil price is now highly sensitive to expected growth rates of the main overseas economies, and every sign of recovery from recession is accompanied by a firm rise in the oil price, not to mention the fact that China is growing rapidly from a low base, and needs more oil for its growth. A higher oil price will spread to other sectors of the economy and inflation will accelerate. This too will hurt the weak, and will put pressure on wages and salaries. A local inflation rate consistently higher than the overseas’ inflation rates, will cause a consistent decline in our exchange rate, in accordance with the purchasing power parity theorem. Is this good or bad? Import prices will rise steadily, and competitiveness in terms of productivity will decline as labour costs rise.

Whither the Rand?
If you can answer this confidently you can make yourself a lot on money! A recent study showed that the Rand against the Pound should, on economic fundamentals, be about R8 to the Pound, a long way below the current rate of over R11. The difference reflects the world’s assessment of SA as a third-world country. Will the Rand ever lose this political discount? It seems unlikely. The Rand is strong as pointed out in the Southern Cross article, because foreign money is flowing into SA to take advantage of our much higher interest rates. Also, the USA monetary authorities are using a policy euphemistically called Quantitative Easing, pouring Dollars into the USA economy to assist financial liquidity in the country and to pull it out of recession. The increase supply of Dollars causes the Dollar to decline (and as this happens the gold price rises. If the Rand falls, the Rand gold price could rise).
It seems likely that the Rand is not too far off its lowest level. Every time there is a third-world nation calamity, currencies such as ours fall quickly as investors sell off. The Rand’s strength appears to be more a sign of serious economic problems overseas than a result of the relative health of the SA economy. When these problems cease (when?), it is probable that the Rand will fall. The G20 nations themselves are in disagreement about exchange rates and there are threats of a currency war.

Conclusion
A case for a weaker Rand is not a one-way case. We will have to pay more for our imports, especially oil, which is very likely to rise as world economies resume growth. Inflation will rise. But we will get more for our exports, which will also be cheaper to overseas buyers. It is a trade off, and at the moment the Reserve Bank is very concerned about inflation and its destructive effects.