What's the story with the Rand?

Suddenly everyone wants to know what 'a current account deficit' is. Why? Because the 'current account deficit' (CAD) is currently being fingered as the culprit for causing the latest Rand weakness. Our current account deficit ballooned to 6.4% during the first quarter of 2006, narrowing slightly to 6.1% for the second.

Bluntly put, as a country we are consuming more than we are producing, i.e. we import more than we export. Foreign countries pay us for the goods we export in their currencies, so that money comes into the country and is used to buy Rands, which is good for the Rand. Imports, on the other hand, have to be paid for in foreign currency, so there we have to sell Rands, which is not good for the Rand. When one exceeds the other, you either have a surplus or a deficit. After many years of running a surplus, SA moved into deficit early in 2004.

Our current account deficit has been growing (widening) and recently reached record levels. The thing about current account deficits is that they don't automatically weaken your currency; they wait until you're getting punished anyway, and then they make sure the discipline is twice as severe!

For example, we have had a current account deficit for some time now, but it has been masked by money pouring into our equity markets for the past few years. As long as money is pouring into your bond and equity markets, the cravings of the CAD are kept at bay. When times are good, the CAD lurks, albeit not threateningly, in the background. When times change, the CAD becomes vicious.

During the 'May correction' this year, most countries were affected, but countries with the biggest current account deficits (Turkey, SA, Brazil) were punished hardest. For ages, economists have been warning, largely to deaf ears, about the CAD!

So what has caused the CAD to rise to such prominence and start inflicting pain? A cocktail of events, which has recently seen the glass go from half full to half empty in the eyes of many South Africans. These factors include issues around government succession (exaggerated by the corruption case being thrown out of court and some of the rhetoric arising from the Cosatu conference); a spike in crime and the media attention devoted to covering it, and rising US interest rates making it more attractive for foreign money to stay in the traditional safety zones such as the US$, as opposed to searching the globe hunting for yield. Perceptions of our equity market and currency no longer being dirt cheap have further fuelled concerns. All of the above create a fear that those equity/bond market inflows that for so long have fed the cravings of the CAD and kept it satisfied, might dry up. This has seen the currency slip to three-year lows.

Thailand has just had a military coup while their president was overseas - a massively abnormal event which makes our issues pale into insignificance. Not only do they not know who is going to be running the country next, they're not even sure who (if anyone at all) is running it now! Yet, their currency only fell by 1%. Why? Partly because they are a more illiquid market than us, but also because they are running a current account surplus, which is supporting their currency.

So what should you be doing?

The answer is nothing. We are in the midst of a 'storm' with the currency and now is not the time to change sails or direction. Nobody can say where the currency will go in the short term, and reacting irrationally during times of turbulence can prove very costly. The Rand has been strong for some time and practically every market commentator has been urging investors to take advantage of that strength to diversify offshore. So if you haven't, you really only have yourself to blame. Unfortunately, as is always the case, if our call centre gives any indication, a 25% hike in the price of the US Dollar since the R6 levels has only made investors want Dollars more.

There is, however, a silver lining, and that is that the weaker Rand will improve the CAD, grow the economy, create jobs and thereby reduce unemployment and crime.

Source: Jeremy Gardiner: Director Investec Asset Management