While the South African rand has historically been characterised with high volatilities, the recent levels of gyrations of the currency, particularly against the US dollar has been quite unprecedented. How does this volatility affect South Africa’s economy?
There are 36 countries in the world that follow a floating exchange rate arrangement (IMF, 2014), South Africa like its BRICS counterparts, Brazil and India, belongs to this group.1 There are also a number of leading emerging market economies such as Turkey, Thailand and South Korea that pursues a floating foreign exchange arrangement as well. Floating exchange rate regimes, naturally, are characterised with increased volatility. Thus, like all financial assets in emerging markets, the perceived high political risk premium associated with these markets exacerbate the level of volatility of their currencies.
While the South African rand has historically been characterised with high volatilities, the recent levels of gyrations of the currency, particularly against the US dollar has been quite unprecedented.2 Given the South African rand (ZAR), like most convertible currencies in the world that are allowed to float freely, volatility then becomes a natural consequence. The currency would see volatility as along as it is allowed to float. So the question really is not whether there would be volatility, but rather, how much volatility would be seen over a period. In the case of South Africa, the fact that the currency is widely traded globally exposes it to frequent fluctuations.3
What explains the rand exchange rate fluctuations?
The ZAR foreign exchange rate, like most tradeable financial assets is by and large driven by demand and supply. There are a considerable number of market participants whose behaviour determine the demand and supply dynamics in the market. These include individuals and institutions that plan to acquire South African assets, and this include, both real and financial assets. Exporters and importers in South Africa and elsewhere that trade with the country also constitute a critical source of demand and supply of the local currency. Lastly, we have currency speculators who take a position in the market depending on their expectation of movement in the rand that may work to their favour. The people actually doing the trading of the currency are commercial and investment banks, central banks, asset and fund managers, corporate institutions as well as pension funds.