adminJac Laubscher
IT IS probably fair to say that the exchange rate of the rand, specifically against the US dollar, is the economic indicator that attracts the most interest among South Africans almost every day.
Changes in the exchange rate tend to be simplistically ascribed to purely domestic factors, including political events.
The real world of foreign exchange, of course, looks rather different, with currencies continuously buffeted by a panoply of forces from across the globe, some of which some are of a short-term, passing nature, while others are more fundamental in nature and exert their influence over a long period of time.
The rand is generally regarded as a commodity currency, along with the Australian dollar, the Chilean peso and the Brazilian real, among others. But is it true that the exchange rate of the rand mainly takes its cue from commodity prices?
A recent study by the Bank for International Settlements (BIS) of the behaviour of the exchange rates of 11 commodity-exporting countries, including SA, provides some useful and interesting perspectives on the most important drivers of the exchange rate of the rand.
The study develops a country-specific commodity price index for each country, depending on its commodity export profile.
The South African basket is made up of 10 commodities, with platinum, coal and iron ore being the top three in terms of their weight in the index (gold comes in at number five on the list).
The Brazilian country-specific commodity price index is the least volatile of the 11 countries, followed by SA. SA’s index is furthermore highly correlated (more than 80%) with those of Australia and Peru. By contrast, the South African rand is the second-most volatile commodity currency after the Russian rouble.
It is quite striking that all countries (except Russia) with a higher share of commodity exports than SA experience less exchange rate volatility, in spite of SA’s country-specific commodity price index being relatively less volatile.
Although commodity exports account for about 60% of SA’s total exports, it is still substantially less than, for example, Australia (79%), Chile (85%), and Russia (80%), but comparable to Brazil (63%).
The study concludes that for 10 of the 11 commodity-exporting countries in the study exchange-rate movements can be predicted based on observed changes in commodity prices on a daily basis for time horizons of up to two months, with a monthly horizon producing the most robust result. The exception is SA, underlining the unpredictability of rand movements. Furthermore, although each country’s exchange rate is strongly correlated with its own commodity price index, the oil price tends to have a general influence on commodity currencies, even for non-oil exporting countries, due to the high correlation between oil price movements and those for other commodities.
Because commodity export prices tend to trump import price changes, the terms of trade for these countries are very sensitive to price movements in commodity markets. They therefore provide immediately available information on the direction in which the nominal equilibrium exchange rate is moving.
An interesting conclusion is that movements in commodity prices are useful for explaining exchange-rate movements that are unrelated to changes in risk appetite, measured by the volatility index (VIX) of the Chicago Board Options Exchange. In other words, commodity prices have their own independent influence on exchange rates apart from the risk-on, risk-off trade.
They likewise dominate short-term government bond yield differentials (so-called carry) as a driver of exchange rates, with the partial exception of Australia and Canada. This result points yet again to the futility of the South African Reserve Bank trying to stem weakness in the rand by raising interest rates (as recognised by the Bank).
What should one conclude from all this? What does it add to our knowledge of the causes of fluctuations in the exchange rate of the rand?
The conclusion seems to be clear: the rand is indeed a commodity currency, but it behaves less like one than its peer group.
Clearly the rand is to a greater extent influenced by other forces, including financial flows of a fundamental as well as position-taking nature, making it the least predictable commodity currency.
This makes life rather difficult for anyone who has a vested interest in the external value of the rand, from the Reserve Bank to businesses in the tradeable sectors of the economy. The lesson: do not try to predict the exchange rate, rather hedge the risk. — Business Day
• Jac Laubscher is an economic adviser at Sanlam.
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