Why The SA Rand And The SA Economy Are Out Of Sync

By Staff Published: April 24, 2016, 12:01 am
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From TheConversation. Story by Matthew Kofi Ocran, professor of economics, University of the Western Cape.

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 , 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.

An example of this played out in South Africa in December 2015, when the country’s finance minister was 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 16 rand per U.S. dollar.

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 10th 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 U.S. 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.

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 favorable 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.

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 No. 1 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.

 

Read more at TheConversation.

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