Print this page

'Rand overvalued if GDP above 3% sought'

Office, Retail, Industrial, Hotels and Residential
Posted On Monday, 26 May 2003 02:00 Published by
Rate this item
(0 votes)
If South Africa hopes to see real gross domestic product (GDP) above 3% in 2003, the rand is significantly overvalued, according to ABSA senior economist John Loos.
If South Africa hopes to see real gross domestic product (GDP) above 3% in 2003, the rand is significantly
overvalued, according to ABSA senior economist John Loos.

He suggests that to attain a 3% real GDP growth the rand would need to trade at an average exchange rate of 11.45 rand to the dollar which would require a sharp depreciation to around 15 rand per dollar soon after the middle of the year.

This would severely dent hopes of achieving the SA Reserve Bank's inflation target but, in the short term, would cushion the economy against the impact of a slow global economy and should also curtail job losses,
Loos argues.

Loos says that what the recent strength of the rand has brought home is that the domestic economy still possesses major structural constraints.

"Rather than promote competitiveness, a weak rand militates against improvements in competitiveness by hiding inefficiencies, and in the three good growth years that have just passed, the pace of structural
improvements has probably slowed rather than sped up," he contends.

When the authorities make mention of the rand not being overvalued, he asserts, they are probably correct in terms of purchasing power parity.

"While an exact purchasing power parity rate of exchange is difficult to ascertain, it would seem that travel to many industrialised countries remains expensive to the average South African, albeit much cheaper than a year ago.

"When it comes to finding an appropriate level for the rand at which the country can realistically compete and achieve a 'desirable' rate of economic growth, the answer is not quite as simple and depends largely on
what one hopes to achieve economically. Crucial policy choices have to be made," he adds.

"Should one hope to see real GDP growth above 3% in 2003, the rand is significantly overvalued. The currency would probably need to trade at a level significantly weaker than the R10.52/dollar average recorded for 2002, given that it was average depreciations of 19.4% in 2001 and 18.2% in 2002 against the dollar that provided major support for economic growth.

"Given its currently strong levels, this would require a major depreciation that would severely dent hopes of achieving the inflation target. In the short term, however, this would cushion the economy against the impact of the slow global economy, and should curtail job losses too," Loos argues.

"In our baseline forecast we have forecast a dollar/rand exchange rate average of R8.07 for this year, three 100 basis point interest rate cuts and a real GDP growth rate of 2%.

"Our economic model suggests that to attain 3% real GDP growth an average exchange rate of R11.45/$ would be appropriate, all else remaining equal.

"To get to this average for the year would require a sharp depreciation to around R15/$ soon after the middle of the year. A further, and unlikely, assumption is made that even under conditions of rapid exchange rate weakening, the Reserve Bank would still cut interest rates by 300 basis points.

"A further result would be that the 2004 inflation target would almost certainly be missed.

"An environment of rapid rand depreciation, relaxed monetary policy, and high inflation is hardly conducive to attracting long-term capital flows when investors would probably witness their investment falling in value in hard currency terms. The promotion of greater inefficiency is a further deterrent of long-term capital.

"It is believed, therefore, that the average economic growth of above 3% per annum was unsustainable because it occurred partly for the wrong reasons. Improved economic growth should be the result of real structural changes that are aimed at improving efficiency and productivity in the economy.

"Considerable structural improvements have occurred through the 1990s and early-2000s. However, the pace of such improvements is likely to occur more rapidly in the event of a strong currency that offers little effective protection than in the case of a weak currency. From this perspective, a strong rand policy would thus appear the desirable option.

"The authorities appear to have opted for a strong rand policy, judging by recent statements that the currency is not overvalued. The recent elimination of the Reserve Bank's net open foreign currency position is further indication of their intentions. This policy choice is also appropriate in terms of the policy of inflation targeting, and it is believed that a good performance by the rand, without any significant shocks, will enable the attainment of the 3% to 6% average CPIX inflation target in 2004.

"However, the effective stripping away of an important source of support and protection to the economy will not make the economy a comfortable place for business, government or labour to operate, and could result in significantly lower economic output growth as well as further formal sector job loss in the short to medium term."

Loos says it is also important to realise that the blame for many of the inefficiencies existing in the economy does not lie solely at the door of the private sector.

"Business finds itself operating in a less-than-perfect environment from both a government service delivery, regulatory and a labour point of view," he says.

"A strong rand policy will therefore be a major test of government's will, as it implicitly requires large-scale improvements in areas such as labour market policy as well as skills development if the problem of long-
term job loss, which recently appeared to just be turning for the better, is to be addressed.

"Until such time as the required structural improvements are achieved, and in the absence of protection from the rand, it is realistic to expect that the global economic cycle will once again play a major role in
determining domestic economic growth performance.

"Given the current global conditions, and domestic impediments, a real economic growth rate of nearer to 2% than 3% may turn out to be a significant achievement in 2003."

 I-Net Bridge
Publisher: Business Day
Source: Business Day
eProperty News

Latest from eProperty News