The South African rand, like many emerging market currencies, is known for its volatility and this fluctuation in value is influenced by a variety of factors that can have significant implications for the country’s economy. Understanding the causes of rand volatility is essential for policymakers, investors, and businesses to ensure its impact can be managed and mitigated. In this article, we will explore the key factors contributing to the rand’s volatility to ensure you as an investor understand the forces driving this important economic phenomenon.
Domestic Political Uncertainty
Political stability is a critical factor influencing the value of any currency, especially for an emerging market, such as South Africa, as it is an indication of the risk an investor’s investment is exposed to. Foreign investors will quickly withdraw their investments and invest in an alternative country while local investors may also decide to diversify into foreign markets during times of sustained and persistent political uncertainties. Political uncertainty has widespread implications for all sectors of the economy and if the returns no longer justify taking on such risks, investors will move their money offshore.
For investors to take such money offshore, they need to sell their rands, which will cause the rand to lose value and effectively depreciate. Changes in government policies, political or corruption scandals, and upcoming elections are all common examples of causes of political uncertainties. Conversely, political stability and clear, investor-friendly policies can bolster the rand.
Commodity Price Uncertainty
South Africa is a major exporter of commodities such as gold, platinum, and coal. The prices of these commodities on the global market significantly impact the value of the rand. When commodity prices are high, South Africa’s export revenues increase, strengthening the rand. However, when prices fall, export revenues decline, weakening the rand. The volatility of commodity prices is influenced by various factors, including global supply and demand, geopolitical tensions, and changes in technology or consumer preferences.
Global Market Volatility
The rand is also affected by global market conditions. During periods of global economic stability, investors are more likely to invest in emerging markets, such as South African investments, as they are more willing to take on risk for higher returns. This demand for our local investments will see an increase in demand for the rand which will strengthen our currency. However, during times of global financial instability, such as during a financial crisis or geopolitical tensions, investors tend to move their capital to safer assets and geographies, causing the rand to depreciate. The interconnectedness of global markets means that events in distant parts of the world can have a significant impact on the value of the rand.
Inflation Expectation
Inflation expectation plays an important role in the value of our rand and to understand why we need to understand the relationship between inflation rates, exchange rates and interest rates. Emerging economies, such as South Africa, have a higher inherent risk than developed countries, and therefore emerging economies need to pay investors a higher return to justify receiving their investment. For this reason, interest rates in emerging markets are typically higher than that of developed economies and during times of global economic stability, international investors, seeking higher returns will consider investing in emerging markets. When they do the demand for our local currency will increase leading it to strengthen.
When global inflation starts to increase, reserve banks react by increasing interest rates as a way to discourage consumers from spending in hopes of bringing inflation back under control. This rise in interest rates combined with a more cautious investment environment will see global investors moving their money back to developed economies presenting lower risk, and although still lower than emerging markets, their interest rates will be higher than before. This outflow from our emerging economy will result in a depreciation of the rand as more investors are selling it. We can therefore see that during times of higher global inflation expectations the rand tends to be weaker.
The volatility of the rand is influenced by a complex interplay of domestic and global factors. Domestic political uncertainty, commodity price fluctuations, global market volatility, and inflation expectations all play significant roles. Understanding these factors can provide valuable insights into understanding how and when the value of the rand will change, allowing investors to make more informed decisions.
