South Africa is more than one of sub-Saharan Africa’s largest and most developed economies. As a global producer of the world’s diamonds with a market system that continues to attract international investors, South Africa is poised to move beyond its “emerging” market status. The rand, the official and heavily traded currency, could very well tell the story of the country’s market dynamics.
From a geopolitical point of view, the rand is also a currency that provides a view into various social and economic issues within the country, all of which international traders keep their eyes on.
Who Loves The Rand?
As far as sub-Saharan African currencies are concerned, the rand is the most heavily traded on a daily and monthly basis. In what market observers refer to as “real money” investors, which can be a variety of different asset managers such as pension funds, insurance funds, sovereign wealth and endowment funds, the rand is in their basket.
There are also a large number of hedge funds from around the world that will often trade the South African rand. Banks and corporations that need access to the USD/ZAR market for the purpose of international trade are also playing the currency. In South Africa, the FX market is primarily dominated by corporations. Institutional investors are not as active, “due to historical foreign exchange controls”, explains James Lord, a London-based emerging markets strategist with Morgan Stanley.
Nevertheless, the South African rand remains one of the most liquid developing market currencies. As such, it does at times trade as a proxy for the developing market universe as a whole in terms of expressing a view, either negative or positive.
Stephen Gallo, European Head of FX Strategy with BMO Capital Markets explains that the rand can also tend to “lead other currencies on the decline and on the advance,” because of its liquidity and the aforementioned reasons.
“Fundamentally, its balance of payments deficit means it can do well when appetite for risk is elevated,” says Gallo. “But it can also seriously underperform when flows into the developing market space dry up, as South Africa requires substantial net foreign inflows of capital to finance itself.”
South Africa’s gross external debt as a percentage of GDP stands at more than 35 percent, up from around 20 percent in 2005, according to published data.
International Appeal Continues
When compared to fellow emerging market currencies, South Africa’s currency holds its own. Will Patrick, London-based Executive Director of FX Products with CME Group, notes that the rand is the only BRIC currency that utilizes CLS settlement, a global market infrastructure system for FX trade settlements that mitigates credit risk at the settlement of a transaction. This makes it more appealing to international investors and promoting its cause as an international currency.
An April Bank of England London Foreign Exchange Joint Standing Committee report lists the Rand as a top 15 FX currency with $26.4 billion in daily notional value traded. Rand futures began trading in 1997 at the Chicago Mercantile Exchange, and more recently in 2007 on the Johannesburg Stock Exchange.
However, “volumes have been muted when compared to the OTC market,” says Patrick. And while the USD/ZAR cash is no longer seeing the rapid growth that the Indian rupee (INR) or Chinese renminbi (CNH) are experiencing, it is by “more a mature market in line with the ruble (Russia), but having that benefit of CLS Settlement at finality of any transaction.”
Data about the rand’s popularity doesn’t tell the whole story. There’s a real appetite from banks and other investors for an exchange-listed FX contract that looks more like the OTC product, according to Patrick. For that reason, CME Group is re-launching the rand contract today.
Market observers agree that the rand is in a class by itself. As far as BRIC and fellow emerging market currencies measure up, the comparison between the rand and the various currencies is not the easiest to compare.
Brazil’s currency, for example, is another burgeoning currency and in some respects the darling currency of some international FX traders with their eyes on Latin America. However, to compare the two would be similar to comparing “an apple and a pear”, says Gallo. “Each currency has its own set of fundamental strengths and weaknesses,” he says.
So while South Africa tends to seriously lag behind other countries like Brazil, the latter faces “an overly regulated labor market, an inadequately educated workforce, high tax rates, thick bureaucratic ways and inadequate supply of infrastructure”, to name a few of Brazil’s issues says Gallo.
But broadly speaking in terms of overall development or competitiveness, “Brazil and South Africa are roughly on par,” he says. “Although the chances for policy instability in South Africa are probably a good deal higher than they are in Brazil, leaving room for a potential nasty result for the rand, relative to the Brazilian real.”
This, Gallo explains, probably goes a long way in helping to explain why both the rand and real witnessed similar declines versus the U.S.dollar over the May through mid-July period, which encompassed the bulk of the strains in the developing market space. Historically, he says, “the volatilities of each of these currencies have been roughly equal, although the Brazilian real has tended to be higher by a modest amount.”
“I think interest in South Africa and its currency will ultimately grow,” says Gallo. “But there are a number of issues holding the pace of growth back. As the fall in the rand as a result of the Fed scaling back its bond buys clearly demonstrates, South Africa will have to adjust so that its growth and capital inflows are not highly dependent on the availability of cheap global liquidity and sub-par risk premia.”
Currently, the rand is the16th most traded currency in the world, with BIS statistics reporting some $27 billion worth of it handled every day. Roughly 55 percent of the currency trading is done offshore, primarily in London, with around 45 percent onshore, mainly in Johannesburg.
“[The rand] is both an institutional and corporate play,” says Greg Kennelly, a Johannesburg-based currency dealer with South Africa’s Rand Merchant Bank. “The institutional side comes from offshore with international investors very active in South African bonds, equities and derivatives. Real onshore trades come mostly from corporates. Local institutions are still not big plays in the rand, although this should change over time as exchange controls are lifted and as currency hedging becomes the norm.”
So while South Africa has been put into some global investment indices, in most cases it remains classified as an emerging market currency with true upside and long-term potential. Although it is extremely volatile – competing with the Brazilian real to be the most volatile in the world – the main driver of volatility is what happens in the global financial markets, says Kennelly, “because of its high yield nature, the rand tends to follow global risk appetite closely.”