BRIAN KANTOR: Impressive Boks a case study for SA success

South Africans travelling abroad should not blame the rand for their lack of purchasing power — at least not lately. In mid-January 2016 a dollar exchanged for R16.80 and the pound for R24. Observers of the gyrations of the foreign-exchange value of the rand should know that the rate has had little to do with differences in inflation between SA and its trading partners. The rand has consistently bought less abroad than at home.

The exchange value of the rand with the dollar or pound has been weaker than its purchasing power parity (PPP) equivalent rate of exchange ever since 1995, when the capital market was opened up, though with varying degrees of weakness. Had the rand simply followed the ratio of the SA consumer price index (CPI) to the US or UK CPI since 1995, a dollar would now cost a mere R8. Since 1995 the difference between SA and UK inflation has been 3.3% a year, while the pound has on average cost 8.2% more in rand.

It is not merely that the rand has depreciated by more than differences in inflation — it is expected to continue to weaken by more than these expected differences. It is expected to lose its dollar value by an average rate of 7.6% a year over the next 10 years and at an average 6% rate over the next five years. Known as the interest carry, these are the current differences between the market-established rand yields on RSA bonds and the dollar yields on US treasury bonds of the same duration.

While helpful to exporters and import replacers competing in home and foreign markets — and to incoming tourists — this expectation of further consistent rand weakness has a damaging downside. It raises the cost of funding rand-denominated debt, increasing the required return on securities that are expected to lose their dollar value at a rapid rate. Expected rand weakness sharply reduces the expected return from the RSA 10-year bond to under 3% per annum (10.4% nominal yield less 7.6%), less than the same return in dollars offered by a US treasury bond.

The expected rate of inflation can be accurately estimated or implied in the same bond markets. It can be measured as the difference between a vanilla government bond and an inflation-protected alternative of the same duration. The compensation to investors in the US accepting inflation risk is an extra 2.65% a year for a five-year bond and 5.91% extra for rand investors in RSA bonds. This difference in expected inflation of 3.2% per annum is significantly less than the 6% rate at which the rand is expected to weaken against the dollar over the same five years.

PPP does not only not hold — it is not expected to hold in future. Sadly, therefore, even reducing expected inflation may not much improve the outlook for the rand, which is essential if the cost of raising foreign or domestic capital is to be reduced.

The full explanation for the exchange value of the rand is to be found not in PPP but far more in the varying flows of capital into and out of emerging markets generally, and to or away from the dollar. SA-specific risks move the  ratio of rand to emerging-market currencies about this long-term one-to-one ratio. The rand and other emerging-market currencies respond similarly to the same degrees of global risk tolerances that drive the dollar stronger or weaker.

The task for SA is to promote capex and so economic growth by improving the outlook for the rand. It could do so by adopting policies that would make SA a superior emerging market, attracting a far lower risk premium. SA’s impressive success in the highly competitive business of international rugby provides the case study. It should be emulated widely.

• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.