by Economics is a complex evolving subject – we unpack some essentials about the South African economy to give you the edge.
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The rand is woefully undervalued
When we pay for goods in a foreign currency, we don’t fully grasp what it is costing us in relative terms. Enter the Big Mac index.
Quick links in the article
- The rand
- Interest rates
- No recession yet
- Junk status
- Global economic impacts
- Income inequality infographic
This is an informal economic parity measure developed by the Economist to understand the true value of one currency in relation to another currency.
Recently, they released the index showing that the ‘true’ value of the rand is R5.85 to the dollar (versus about R14 to the dollar), using the following calculation:
- In the USA, a Big Mac sells for $5.04
- In South Africa it sells for $2.04 (R29.50).
- A South African in the USA would expect to pay R72.79 for the same product that costs R29.50 locally.
- The value of the South African currency would have to sit at R5.85 to the dollar if you were to pay the same amount of money for a Big Mac in both nations
- The rand is, thus, undervalued by 59%
And the reason for the undervaluation?
“Part of the reason why the rand is undervalued is because there is a significant amount of sentiment that gets priced into the actual spot level of where the rand is trading right now,” Mohammed Nalla, head of strategic research at Nedbank Capital told CNBC Africa.
In simplest terms, where money is concerned people, unfortunately, do not always react without emotion, and from there currencies develop a mind of their own.
Interest rates are not at their worst by far
Imagine for a moment the default rate on mortgages if the interest rates were to more than double.
This is exactly what happened in the late 1980s under Apartheid where bank lending rates were as high as 25% at times (versus 10.5% currently for prime and 5.75% for the repo rate).
Interest rates defined
When reference is made to the South African interest rate this often refers to the repo rate (supplied by the South African Reserve Bank) plus the profit added by the banks, otherwise known as the prime lending rate.
Recently, the Reserve Bank decided to keep the repo rate unchanged.
A quick look at historic interest rates
We are not in a recession yet
Experts for some time now have been speaking about tough economic times. Many assume this means a recession, but in technical terms we are not in a recession yet.
The technical definition of a recession is when the economy contracts for two consecutive quarters.
The recently released -1.2% growth rate in the first quarter of 2016 puts South Africa on the edge of recession. If second quarter data shows the same negative growth compared to the same quarter last year, we will then enter a recession.
Last week, the central bank said it now expected the economy to remain stagnant in 2016, compared with the 0.6 percent growth predicted in May.
The International Monetary Fund has reduced its own forecast to 0.1 percent, and the central bank agrees that the economy will remain stagnant.
Therefore, a stagnation is seen as ‘tough times’ rather than a technical ‘recession.
The jury is out on junk status
Junk status means a country is considered non-investment grade and unable to meet its sovereign debt obligations.
There are three rating agencies with global clout (Standard & Poors, Moody’s and Fitch group). Two of the three agencies would have to down-grade South Africa to non-investment grade before it is considered to have hit junk status.
The next risky time for a possible downgrade is December 2016. After a downgrade, typically what happens is an International Monetary Fund bailout and associated economic problems such as a weakening rand.
However, even if we hit junk status, the lowest level the rand could reach is about R16 to the dollar, according to chief economist at Investment Solutions, Lesiba Mothata.
“When the eventual decision to downgrade happens, if it does happen, as a large proportion of the country’s debt is already trading globally at similar levels to those countries rated ‘junk’: as we are already priced for non-investment grade, the depreciations shouldn’t be too drastic,” he explains.
Furthermore, many of the country’s leading financiers also do not believe that a downgrade to junk status in December is a given, including executives at PSG Wealth as well as the CEO of Sanlam Ian Kirk.
However, they all agree that how the next few months play out politically will also be very telling for the SA economy.
In essence, it may swing the pendulum either way.
One of the positives of a credit downgrade to junk status, if it happens, is that a weaker currency will make us a very competitive trading partner.
The government isn’t ALWAYS to blame
Recently a few of our readers voiced concerns that reports of lower food and fuel prices were manipulated by politicians in order to win votes in Wednesday’s elections.
We got hold of AA spokesperson Layton Beard who said:
The AA fuel price predictions are based on publicly available Central Energy Fund data, and that this price is driven by the cost of transportation, as well as the rand-dollar exchange. There are sound economic reasons backing these predictions [and it not a figure manipulated by politicians].
Food price reports were related to predictions of greater rainfall which was a direct result of global weather patterns, data of which is accessible by meteorologists the world over.
However, while we can’t pin the blame on politicians for all the costs associated with living in South Africa, the buck stops at parliament’s door for high unemployment figures and a stagnant economy to name a few.
One of the most unequal countries in the world
It is nothing new that there is a huge amount of inequality in South Africa. Whereas in Australia, the petrol pump attendant might live in similar lodgings to an executive, a 20 minute drive in Cape Town, in contrast, will take you from splendor to squalor.
It is also officially understood, through the Gini coefficient, the most commonly used measure of income disparity, that we are one of the most unequal countries in the world.
Brazil’s Gini was very similar to South Africa’s in 1994.
Since then, inequality in Brazil has fallen, given the rapid rise in secondary school enrollment and graduation rates (without sacrificing quality), the introduction of conditional cash transfers and strong economic growth, according to Haroon Bhorat Economics professor at the University of Cape Town.
In contrast, South Africa since democracy has seen a moderate reduction in poverty levels, combined with a sharp rise in income inequality since 1994. This has all been amid single-digit economic growth.
While all is not lost for the SA economy, as Warren Buffett said, when the tide goes out we can see who has been swimming naked.
There is a great deal of uncertainty in South Africa at the moment – ensure you are not found swimming naked by reducing your debt and ideally starting to build a nest egg before the end of the year.
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