Article by Mike Schüssler, Moneyweb.
The rand is undervalued but interest rates are nicely in the middle.
South Africa has a daily forex turnover of $21 billion a day, higher than many developed economies. Picture: Waldo Swiegers, Bloomberg South Africa has a daily forex turnover of $21 billion a day, higher than many developed economies. Picture: Waldo Swiegers, Bloomberg
Financial market movements are an important part of the daily information an economy gets. When it comes to stock markets, forex markets and interest rates, how does South Africa compare with other emerging markets ?
There are five financial market indicators that are fundamental to an economy (stock market performance has been left out for now).
Stock market size – where does the JSE fit in?
South Africa has one of the best and deepest financial markets in the emerging market world. The JSE is the 18th largest stock exchange in the world, which is impressive given that the country’s GDP comes in at 34th. The JSE was 16th largest just two years ago, but with lacklustre performance it has slipped back a little.
The JSE is only the fifth-largest emerging market stock exchange, but South Africa has the third-largest market capitalisation. This is because India and China have two stock exchanges each, and all four are larger than the JSE. South Africa now has a few other exchanges but they are still small in a world context. They are, however, starting to add interesting dimensions to the overall picture.
The JSE market cap was $988.4 billion at the end of November, which is about three times SA’s GDP. The JSE is by far the largest stock market in Africa; the next biggest, Morocco’s Casablanca, has only about 6% of the market cap of the JSE. Botswana is fourth largest but does not disclose its data to the World Federation of Exchanges (WFE). Its market cap is about $39 billion, which is between Cairo (third largest) and Nigeria (fifth).
After these stock exchanges the next biggest stock market in Africa is Mauritius, followed by Tunisia and Namibia. Thus three of the biggest eight stock exchanges in Africa are in Southern African Customs Union countries.
How important is the rand in a world and emerging-market context?
The fact that the JSE is in the top 20 exchanges in the world helps other parts of the South African financial market – turnover in the rand foreign-exchange market is one example. With the JSE in 18th place with regard to market capitalisation, the rand punches above its weight internationally.
Every three years, the Bank of International Settlements (the central bank of central banks if you wish) does a survey of all forex dealers in over 50 countries where free trade in currencies takes place.
While the US and UK dominate world trading of foreign exchange, South Africa was the largest emerging market regarding volume of foreign exchange traded for a number of years from 1998.
This is a good indicator of the overall importance of a country in the world of finance since bonds and stocks get traded in the local currency – resulting in trade between a foreign currency and the local one.
At present South Africa has the 25th largest forex turnover, and is fifth largest among emerging markets in the dollar value of forex transaction turnover.
China, which had a very small and closed forex market, has in recent years leapt past all the other emerging markets in size and importance, but accounts for just over 1% of the total forex turnover of the world. In SA, the daily turnover (not profits or anything else) is $21 billion a day! Worldwide, forex turnover is in the region of $7 trillion a day.
So, while South Africa is important in Africa and the biggest by far on the continent, it is still very small on a world scale. However, many developed economies such as Ireland do not have the turnover that SA has in the forex market.
The rand is an interesting case of a currency that has been an important emerging market currency – sometimes the most important – but like several South African indicators, it is been overtaken by other developing markets such as China, Russia and India.
South Africa will always be a deep and liquid market in the forex game but is probably going to be overtaken by Brazil in the April 2019 survey on the total turnover and importance of forex volume. SA will then be the smallest of the Brics markets, whereas in 1998 it was the biggest.
However, forex volume is a bit of a vanity indicator once there is enough turnover in a market. I believe around $12 billion is probably enough for a liquid market to function.
How cheap is the rand really?
This is a tricky indicator to value. Many institutions have purchase power parity indices for currencies, but they are often old and get redone every few years as spending patterns change.
It is however an important measure of how confident others (and yourself) are in a country’s future.
For this, I use the Big Mac Index as it comes out once a year and is now available for well over 70 countries and about 56 currencies (remember that the euro represents 19 countries). It measures how much a Big Mac costs in dollars in all of these countries, and compares the figures against the US price. From this, one can see how ‘expensive’ or ‘cheap’ a currency is.
With my focus on emerging market countries, I have the relative value – or undervaluation – of these currencies, and see that many are undervalued at present. The rand is nearly 60% undervalued! But it is not the worst currency by far as seven other currencies have lower relative purchasing power than the US dollar at present.
The Big Mac Index gives much insight into currency valuations. Picture: Daniel Acker/Bloomberg
The Big Mac Index was updated early in January, and the results are interesting. Russia is the most undervalued country at over 70% followed by the Ukraine, Turkey and Argentina. Even the Chinese yuan is undervalued, by 45%.
In fact, 52 of the 55 currencies that feature on the index are, in relative price terms, undervalued. Only Sweden, Norway and Switzerland have currencies that, according to their ability to buy Big Macs, are overvalued.
The most expensive country according to the Big Mac Index is Switzerland. The SA Big Mac costs about $2.23 and the Swiss one $6.62 – so a South African can only buy a third of a Big Mac in Switzerland. Or a Swiss person can get three for the price of one in SA, or four for the price of one in Russia! It’s incredible that anyone still wants to eat a Big Mac in the little mountain country.
So the rand is cheap, but a few places are cheaper. In Russia, your rand will buy you one and a third of a Big Mac for the same price as in SA. In the 20-year history of the Big Mac Index in SA, the rand has always been cheap. But at close to 60%, it is probably overdone. So either the SA rand price of a Big Mac increases in the next year or the rand will bounce back a little – or both.
Emerging market currencies are almost always undervalued, and SA has been one of the most undervalued currencies for a long time. However, the rate of decline has to an extent slowed in recent years but more on this another time.
Are SA interest rates high in an emerging market sense?
The South African Reserve Bank (Sarb) is an inflation hawk and people often say South African interest rates are high. But if we look at the available data from the Bank for International Settlements (BIS), four countries have higher rates than South Africa in their dataset – and all of them are emerging markets. Argentina has an interest rate of over 60% while Turkey has a policy rate of 24%.
The Sarb repo rate is 6.75%, which is on the higher side, but not if one considers that of the five Brics countries, Russia, Brazil and India are all within less than 1% of SA’s repo rate (or within 75 basis points). Russia has a policy rate of 7.5% and India and Brazil are at 6.5%.
China is the only Brics country with a rate of below 5%; at 4.35%, it is the lowest of our Brics partners.
Policy rates should take inflation – or at least future inflation – into account
Having shown that China has a policy rate of 4.35%, what about the fact that China has an inflation rate of only 2.2%? Well, that means they still have a relatively high real policy rate. India has inflation at 2.4%, Brazil at 3.7%, and Russia at 4.3% at present – so the SA inflation rate of 4.5% is the highest of all the Brics countries.
This brings me to the actual real policy rates, since one often hears that SA interest rates are killing the economy and should be as low as China’s as that is what is helping China to grow.
I see this as bollocks since China has a higher real rate than SA! China recorded an inflation rate of 1.9% in December – so that 4.35% rate works out to a real rate of 2.5%, which is higher than the SA real rate of 2.3%
After inflation, of the 23 emerging markets that have policy rates, South African real rates are very much in the middle. Yes, Chile and Poland have much lower rates than SA and some, like Hungary, have negative real rates – the fact is that SA is in the middle here, which shows that our policy rates are not at all out of line for an emerging market.
Remember too that emerging markets are seen as more risky (although in some cases I would debate that) and many, like SA, need to attract savings to help pay for current account deficits.
In simple terms, South Africa’s financial indicators are important, and are not the worst or the highest of the emerging markets out there. The rand is undervalued but interest rates are nicely in the middle, and not much can be said of the stock market except that the JSE is a very large emerging market stock market but a medium-sized one in a world context.
Mike Schüssler is an economist at Economists.co.za.