Menu

Search

  |   Insights & Views

Menu

  |   Insights & Views

Search

Why the rand punches above the weight of South Africa's economy

The South African rand is the 18th most traded currency in the world. Nick Roux/Wikimedia

Is the size of the South African economy out of sync with the ranking of the rand as the 18th most traded currency in the world?

The South African economy is the 33rd biggest in the world, with a gross domestic product of US$350 billion in 2014. But its currency, the South African rand (ZAR), is ranked 18th when the percentage shares of the average daily turnover of the global foreign exchange market are considered.

The South African rand has recently experienced an unprecedented level of volatility – more so than most, if not all, emerging-market currencies. But a greater part of the pain has been self-inflicted.

The low economic growth outcomes in the recent past, as well as the poor growth outlook and domestic political risk issues have all contributed to putting the local currency on the back foot. An example of this played out in South Africa in December 2015, when the country’s finance minister was abruptly fired and replaced with an unknown backbencher. Investors lost confidence in the running of the economy, with terrible consequences for the rand, which reached a new low of more than R16/US$.

Size of economy vs currency trades

But this recent volatility can’t be blamed on the fact that the rand punches above its weight in the foreign exchange market. Other reasons account for this.

South Africa is not alone. There are many other small economies in the world whose currencies have bigger shares in the global foreign exchange market.

For example, the Swiss franc is the sixth most important foreign exchange market in the world, but the country is ranked as the 20th biggest economy. New Zealand is ranked as the 53rd biggest economy, but the New Zealand dollar is the tenth biggest foreign exchange market.

On the reverse side, there are a number of countries with big economies whose currencies are traded very little. This is because they don’t have a well-developed financial market. South Africa’s BRICS partners Brazil and India have much bigger economies than South Africa, but their foreign exchange markets are smaller.

The US and Japan, the first and third biggest economies in the world, also have well-developed financial markets. It is therefore no wonder that the US dollar and the Japanese yen are the first and third most traded currencies in the world.

The Chinese yuan occupies ninth position in the ranking of traded currencies, even though it is the second biggest economy in the world. This is due to the fact that its financial markets are relatively underdeveloped.

This shows that the size of an economy has no role in the tradeability of its currency.

ZAR foreign exchange market size

The ZAR foreign exchange market, like that of any other tradeable asset, is underpinned by demand and supply. These determine its market size.

There are a number of critical players on both sides. They include:

  • Individuals and institutions that plan to buy South African assets – real and financial. Real assets include residential and non-residential properties. Financial assets are made up of bonds, stocks, derivatives and other financial instruments. On the supply side are those who plan to sell these assets.

  • The export demand of South African goods and services is also a major source of demand for the currency. In the same way, the supply side is driven by exporters of South African goods and services

  • Currency speculators. Speculators of the currency buy and sell and sometimes hold the currency for a while to make a return from favourable fluctuations in its value. Speculators are also a source of supply.

Who is doing the buying and selling? A host of players are active in the foreign exchange market of the rand. These include: commercial and investment banks, central banks, securities houses, asset and fund managers, companies and institutional investors such as pension funds.

Benefits and risks

The interest in South Africa’s currency in the global foreign exchange market is a reflection of how the domestic economy is plugged into the world economy, particularly the developed world. This needs to be cherished.

This connectivity is facilitated by a financial system that is well regulated. In fact, it outperforms a great many other developed countries. For example, for four consecutive years the country was ranked number one in the world when it comes to the regulation of securities exchanges.

The benefit of being connected to the international financial market is that South Africa’s market is exposed to a larger number of participants. This contributes immensely to the liquidity of domestic real asset and financial asset markets.

Classical economic theory suggests that high liquidity results in trades being priced correctly. This doesn’t happen in an illiquid market with a small number of buyers and sellers.

The danger posed by speculators

Speculators pose the biggest risk to a currency. Because the rand is traded in all major foreign exchange markets such as the UK, US, Japan, Singapore and Hong Kong, speculators can present a danger to its pricing.

But the risk of an attack by speculators is minimal if the South African Reserve Bank is seen to be pursuing a sensible exchange rate policy. For instance, if the South African Reserve Bank decides to intervene in the rand foreign exchange market with the intention of managing the currency’s exchange rate it may open up the currency for speculative attacks.

A classic example is the famous “Black Wednesday” episode, when speculators broke the British pound on September 16 1992. The British government got its fingers badly burnt in an attempt to support the pound. One speculator, George Soros, is reported to have walked away with $1 billion in a single day from betting against the Bank of England.

Its lesson shouldn’t be lost on anyone.

In fact, the hands of the South African Reserve Bank are tied as far as the rand’s foreign exchange rate is concerned. Even if it wanted to, it couldn’t intervene in any meaningful way to influence the direction of the currency’s foreign exchange rate. This is because it doesn’t have the resources: the foreign exchange market is massive relative to the foreign exchange reserves of the country.

Just look at the numbers. The bank’s gross official gold and foreign exchange reserves are estimated at $47 billion. Given that the value of trade in the rand alone is more than $60 billion in a typical day, it would be foolhardy to imagine that the country’s foreign exchange reserves can be used to prop up the currency’s exchange rate.

That’s not to say that nothing can be done. Undue volatility can be managed. The government and its National Treasury, which oversees the country’s economy, have a role to play. They can make sure that economic policies are sound and stable, and that investor confidence in the country is maintained. The government can also make sure that the rule of law is upheld.

The ConversationMatthew Kofi Ocran receives funding from NRF.

Matthew Kofi Ocran, Professor of Economics, University of the Western Cape

This article was originally published on The Conversation. Read the original article.The Conversation

  • Market Data
Close

Welcome to EconoTimes

Sign up for daily updates for the most important
stories unfolding in the global economy.