Although the Rand has weakened by 8.5% against the Dollar year-to-date, the Rand is far from the worst performing emerging market currency this year. From the beginning of 2015 to end July 2015 the Brazilian Real has declined by a massive 22.1%, followed by the Colombian Peso (-16.9%) and the Turkish Lira (-15.4%). Equally, since the end of 2011 the Rand has depreciated by a substantial 36% against the Dollar, but the Argentinian Peso has lost 53.2% against the Dollar over the same period, while the Russian Ruble is down 47.4%, and the Brazilian Real has declined by 45.3%.
South Africa remains one of the more vulnerable emerging economies given the combination of a relatively large fiscal and current account deficit, recent credit rating downgrades, power shortages, sluggish economic growth, a volatile labour market and a heavy reliance on commodity exports. This vulnerability is compounded by the on-going weakness in commodity prices (a new IMF Working Paper highlighted that the current drop in Chinese imports significantly reduces the export revenue of its trade partners), and the fact that world trade has slowed significantly since the 2008 financial crisis.
In the past few years world trade have averaged growth of around only 2.5%y/y, slowing in May 2015 to a mere 0.4%y/y (see chart attached). This compares with the long-term average annual growth of 8.5% prior to the crisis. With the many emerging economies (including South Africa) very reliant on trade to boost the economy, this slowdown in world trade is putting downward pressure on company’s earnings. Importantly, the slowdown in world trade has also made depreciating currencies less useful in stimulating export growth. Instead, currency weakness is now putting upward pressure on inflation in some emerging economies, including South Africa, which will most likely constrain the ability to use monetary easing to support slowing growth. Again South Africa is a good example.
All of this highlights that it is more important than ever that emerging economies, including South Africa, actively address some of their structural economic challenges. In South Africa this includes weak educational outcomes, deteriorating economic infrastructure, and weak business confidence. There has already been a sharp reduction in the emerging market’s growth premium over mature market economies; which is now just 1 percentage point, down from over 6 percentage points five years ago. After many years of unconventional economic policies that significantly distorted risk-taking around the world, we are re-entering an era when sound economic policy can make a real difference.
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