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Alba Iulia
Wednesday, August 12, 2020

Understanding Currency for ‘dumb’ politicians

Economy Understanding Currency for 'dumb' politicians

Chart showing Zambian kwacha's the exchange rate trend and Inflation
File:Chart showing Zambian kwacha’s the exchange rate trend and Inflation

Dear LT Editor,

Please publish this for those dumb politicians that think that the demise of the Kwacha in due to “natural causes” !!!!!!

Explainer: how currency markets work and why the South African rand is falling

Given that South Africa operates within a flexible exchange rate regime, the value of the rand, like any commodity, is determined by the market forces of supply and demand. The demand for a currency relative to the supply will determine its value in relation to another currency.

Theoretically, the demand for a floating currency – and hence its value – changes continually based on a multitude of factors. In the case of the rand, its current weakness can be attributed to a myriad of structural problems facing the local economy.

The main determinants of a currency’s value include demand for a country’s goods and services. This is closely linked to the growth and national income of its main trading partners.

Equally important is the domestic interest rate. If it is high it is likely to attract foreign capital, causing the exchange rate to strengthen. But high inflation can wipe out the benefit of high interest rates to foreign investors.

Additional factors serve to drive the currency down.

These include a current account deficit. The current account deficit gets bigger when a country spends more on foreign trade than it is earning and has to borrow capital from foreign sources to make up the difference.

This implies that a country requires more foreign currency than it is getting through sales of exports, and it supplies more of its own currency than foreigners demand for its products. This excess demand for foreign currency leads to depreciation in the value of a currency.

Factors such as political instability and poor economic performance can reduce investor confidence. This inevitably forces foreign investors to seek out stable countries with strong economic performance. Thus, a country that is perceived to have positive attributes will attract investment away from countries perceived to have more political and economic risk.

There is a further complication to currency movements. The buying and selling of currencies is no longer driven only by the need to facilitate trade but also by the demand for currencies as financial assets. This means that currencies are bought and sold like any other asset. Decisions by traders – to buy or sell a currency – can have a marked effect.

The impact of the turmoil in China

South Africa’s currency lost 26% of its value in the six months after turmoil gripped Chinese markets in June 2015. This was when the People’s Bank of China surprised markets by executing a 2% devaluation of the yuan and changing the way it traded its currency. The aim was to weaken the yuan to boost its export competitiveness.

This, coupled with slower economic growth, has aggravated the situation for South Africa as well as other African countries that rely on oil and mineral exports to China. Emerging markets most exposed to lower growth prospects and subdued commodity prices have seen the sharpest falls.

The rand is expected to remain under pressure with many analysts predicting that it will fall further in 2016. It is not alone. Many other emerging market currencies have been dealt the same fate.

But the rand is substantially weaker than it might have been. The sudden reshuffling of the finance ministry was seen as weakening one of the country’s key macroeconomic institutions and continues to undermine market confidence.

Implications of the weak rand

The weak rand has a number of implications for the country’s growth prospect. Firstly, the weakening currency carries the risk of pushing up inflation because imported goods are more expensive. This means that the South African Reserve Bank faces a difficult decision. It can keep interest rates low but then faces even higher inflation. This will only devalue the rand further.

If the central bank takes more aggressive action by raising interest rates, it risks stifling growth in an economy that is only growing at 1.5%.

The rand’s weakening could not have come at a worse time for South Africa. The country is suffering from the worst drought since 1992 which has increased food costs and pushed the farming industry into recession. The price of white corn, a staple food in southern Africa, has more than doubled on the South African Futures Exchange in the past year.

With large parts of the economy already in recession, coupled with worsening debt levels and the threat of credit-rating downgrades, it looks like the economy will contract. This implies that Finance Minister Pravin Gordhan has limited room to boost spending.

The weak rand will also see the cost of imported goods for consumers rise. In addition, while the rest of the world benefits from record low oil prices, the country’s weaker currency means it will not able to take full advantage of this and may face higher fuel prices in the near future.

On the flip side, the weaker rand does have some benefits. It is helping mines stay afloat. And gold mines could make profits again as the gold price has held up more than the prices of other minerals. There may also be a boost in tourism.

The weaker rand may also have short-term benefits for sub-Saharan countries importing substantial volumes from South Africa.

Finally there may be a boost for local exporters. But this could be stifled by the rise in the price of imported raw materials which will contribute to higher costs of production for manufacturers.

Is the rand over-traded?

In 2013 the South African rand was ranked as the 18th most-traded currency in the world. Surprisingly, while South Africa accounts for only 0.3% of the world’s daily foreign exchange market turnover, the rand accounts for 1.1% of worlds daily currency trading.

This difference is largely due to the daily trade taking place outside South Africa by non-residents. This is partly a result of virtually no exchange control restrictions for foreigners trading the rand but many in place for South Africans who wish to trade in foreign currency.

This has been highlighted as a further problem faced by the central bank in trying to influence the value of the rand.

Source:The Conversation

10 COMMENTS

    • Elitist approach………..,the kind of ‘economics’ I understand: building a road, school,brigde,university,hospital e.t.c where there was non…….the PF is walking their talk and that’s why am voting for ECL.

    • Who is going to teach in those Universities?
      Who will go into those universities? Will you pay them the allowances?
      Go ahead, create white elephants everywhere!

  1. YEP……The issue of currencies cannot be justifiably used to gain votes because Zambia is not the only country affected by the globally strong performing US dolar. The whole africa is in pain of the powerful US dolar.

    The issue of droughts also cannot win a person who does not deserve to rule Zambia because as far as people know, the rain season is not controlled by PF.

    Zambians love peace and cannot afford to vote for selfish/tribal individuals who just want to be in state house without a better plan. GGGEEENNNOCCCIIIDDDEEEE is what we do not want ….

    Zambians cannot vote for people who call other tribes as devil. Rwanda and Burundi had a bad experience when they voted for a force, tribal leader and that is what every well meaning ZambianS are thinking about before voting.

    • @MUNYA
      Did you actually read the article? You obviously missed the piece about National debt and Government borrowing undermining investor confidence. And the credit rating dowgrades due to the appointment of incompetent Ministers of Finance!

  2. I am lost. Are we talking about S.A or Zambia? The chart is about ZMK but the article talks about the Rand and S.A.

    • I think he brought up S.A. because the politicians have been saying the currency depreciation is affecting the whole southern region. Moreover, he used it as an example. Most of the factors he gave about S.A. can apply to Zambia too.

  3. This is well researched and I doubt if most our politicians both in PF and the opposition as a whole will understand this article. Trading in currencies like any other commodity? I can see even Zambians will not benefit from the low oil prices on the international market. With economic sanctions lifted on Iran it will mean more oil on the international market further depressing the prices. Our dependence on China has done more damage to our economy. Ours has become a parasitic economy. Its like when the Chinese economy sneezes we catch the cold. Ya CHimbwe no plan. We in for it until some time. Lets learn to live with this situation. We grow own maize we sell it cheaply and will be importing the same at a higher price

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