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Why the South African rand is falling

The value of the rand, like any commodity, is determined by the market forces of supply and demand.

The demand for a currency relative to the supply will determine its value in relation to another currency.

In the case of the rand, its current weakness can be attributed to a myriad of structural problems facing the local economy.

The main determinants of a currency’s value include demand for a country’s goods and services. This is closely linked to the growth and national income of its main trading partners.

Equally important is the domestic interest rate. If it is high it is likely to attract foreign capital, causing the exchange rate to strengthen. But high inflation can wipe out the benefit of high interest rates to foreign investors.

Additional factors serve to drive the currency down.

These include a current account deficit. The current account deficit gets bigger when a country spends more on foreign trade than it is earning and has to borrow capital from foreign sources to make up the difference.

This implies that a country requires more foreign currency than it is getting through sales of exports, and it supplies more of its own currency than foreigners demand for its products. This excess demand for foreign currency leads to depreciation in the value of a currency.

Factors such as political instability and poor economic performance can reduce investor confidence. This inevitably forces foreign investors to seek out stable countries with strong economic performance.

Thus, a country that is perceived to have positive attributes will attract investment away from countries perceived to have more political and economic risk.

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The impact of the turmoil in China

South Africa’s currency lost 26% of its value in the six months after turmoil gripped Chinese markets in June 2015.

This was when the People’s Bank of China surprised markets by executing a 2% devaluation of the yuan and changing the way it traded its currency. The aim was to weaken the yuan to boost its export competitiveness.

This, coupled with slower economic growth, has aggravated the situation for South Africa as well as other African countries that rely on oil and mineral exports to China. Emerging markets most exposed to lower growth prospects and subdued commodity prices have seen the sharpest falls.

The rand is expected to remain under pressure with many analysts predicting that it will fall further in 2016. It is not alone. Many other emerging market currencies have been dealt the same fate.

But the rand is substantially weaker than it might have been. The sudden reshuffling of the finance ministry was seen as weakening one of the country’s key macroeconomic institutions and continues to undermine market confidence.

The Conversation

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