Crisis pits rate cuts against rand support

JOHANNESBURG – Rand weakness and concern about the strength of the global economy have sparked a debate among economists about the role of high interest rates to support the currency.

The South African Reserve Bank’s monetary policy committee (MPC) will meet next week to decide by how much to cut the official repo rate, following the cut last month of half a percentage point to 11,5 per cent.
Concerns that the recession in major economies will spill over into the local economy have brought calls for aggressive rate cuts, in line with those by other central banks.
Conventional theory is that high interest rates support a currency by attracting deposits from countries that offer investors lower returns.
Over the past few years, the rand was often supported by the carry trade, which involves investors borrowing in low-interest rate currencies and investing in South Africa.
However, economists have now started to question the traditional view that high interest rates are needed to support the currency.
They argue that equities are often a more powerful attraction than high interest rates, and their performance depends on economic growth – which, in turn, is directly affected by the cost of borrowing.
A comparison of changes in the rand and the repo rate over different periods show that both theories could be correct.
When the repo rate fell from close to 22 per cent in September 1998 to 9,5 percent in 2001, the rand weakened from R6 to the US dollar to nearly R14.
The worst of the fall was because of global risk aversion following the terror attack on New York in September 2001. Before the attack, the exchange rate was about R8,50 to the dollar – still a significant decline.
But starting in mid-2003 and continuing until early 2005, rate cuts resulted in the rand strengthening to less than R6 to the dollar. And the currency weakened in 2006 as interest rates rose.
Rand weakness continued on Friday as concern about global banking losses, expectations of poor results from top US companies, and news that the UK economy shrank by 1,5 per cent in the fourth quarter of last year increased the level of uncertainty in financial markets.
Equity prices fell and the rand, along with the currencies of other emerging markets, lost ground as ‘global risk appetite dwindled further’, according to Ian Cruickshanks, the head of strategic research at Nedbank Capital.
The currency lost about three per cent in the day, Cruickshanks said.
‘It traded in a wide range, between a best level of R10,03 to the US dollar and R10,46, because of a totally negative environment, worsened by continuing capital calls by banks around the world.’
Bloomberg reported on Friday that analysts at French bank Societe Generale had cut their estimates for company earnings worldwide by US$1 trillion (about N$10.2 trillion) since October.
On Friday the rand’s fortunes continued on the volatile trend that began as the world’s banking problems accelerated last September, when US bank Lehman Brothers sought bankruptcy protection.
As banking losses mounted further, along with those of vehicle manufacturers, the world’s major economies moved into recession.
Rising risk aversion was reflected in the rand’s movements. The currency which could buy nearly 13 US cents in September, could buy only 10 US cents for most of last week – a fall in value of more than 20 per cent. -Business Report