The latest rand slump was triggered in part by confirmation that South Africa is in recession: The economy shrank by 0.7% in the second quarter, after a contraction of 2.6% in the first.
Investors are now worried that Moody’s will downgrade South Africa’s credit rating, which will strip us of our investment rating. Our government bonds will be rated as “junk”, meaning the state will have to fork out much higher interest rates to get money.
But the pressure on the rand is not only because of local factors – we are currently living through an emerging market sell-off, says Arthur Kamp, economist at Sanlam Investments.
A strong US manufacturing report, released on Tuesday, bolstered expectations that US interest rates will be hiked. Higher interest rates make a currency more attractive, as investors will earn more interest.
This put emerging market currencies under more pressure - on average, emerging market currencies are at their lowest levels since April 2017.
Investors are also worried about the financial position of countries like Turkey and Argentina, and South Africa’s government finances are not looking healthy either, says Kamp.
In July, South Africa had a budget gap of R95.98 billion (meaning government spent much more than it got in tax), the largest on record. Also, South Africa is importing more than it is exporting – its current account deficit is currently 4.8% of GDP, one of the worst in the world.
Fuel is SA’s biggest import product. If the rand weakens, oil – which is priced in dollar – is immediately more expensive.
This week, government has intervened to cushion the blow of higher fuel prices. Petrol prices were supposed to go up 25c a litre on Wednesday, but only rose by 4.9c/l, as government subsidised the rest.
This is expected to be a once-off, and as it stands, according to government calculations, petrol prices will be hiked by at least R1.15 a liter - and diesel by a massive R1.40 - in the first week of October.
Petrol under-recovery now well over R1 per liter. Next month is crunch time - fuel companies won't absorb or fund such a shortfall, govt can't afford to either. So we'll have to pay. Be prepared. We're living in a fool's paradise. There will be consequences— Syd Vianello (@Siddels1000) September 5, 2018
While higher fuel prices will have an immediate knock-on impact on the cost of delivering all goods and food, resulting in higher prices, the rand/dollar price has a more direct impact on grain prices
South Africa’s maize and wheat prices are linked to the global dollar prices.
Already, in the past 48 hours, maize and wheat prices have shot up by R60 a tonne, while soybeans are now R100 a tonne more expensive.
According to Luan van der Walt, an economist at Grain SA, it usually takes about three months for these higher prices to feed through the value chain to the end consumers.
The proposed scrapping of VAT on white bread could help cushion the blow.
The prices of electronic equipment are among the most affected by a weaker rand, says Johann Els, head of economic research at Old Mutual.
But it could be that prices won’t be hiked by the same margin as the rand slump. It is likely that retailers may not have yet passed on the full saving of the stronger rand earlier this year, he told Business Insider SA earlier.
There’s a risk that the monetary policy committee of the SA Reserve Bank hikes rates when it meets on 18 September, says Kamp.
While there is little sign of consumer prices heating up because of stronger demand, the bank has been clear that it is looking ahead to the impact a weak rand could have on inflation.
“It is never easy to hike rates when the economy is in recession – but there is a precedent,” Kamp adds. In the 1990s, the Reserve Bank increased rates during the Asian crisis, when the local economy was in the doldrums.
He expects that the bank will probably not increase rates this month, but wait to see if the current rand weakness persists. If it does, an interest rate hike looks likely in November.
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