The South African rand (ZAR) is a free-floating currency, local to Africa's second-largest economy.^[1] Operating without a commodity or currency peg, the rand's value is relative to evolving levels of supply and demand. As individuals, banks, corporations and foreign nations stockpile the rand, it appreciates in value. Conversely, a perceived lack of worth depresses demand, leading to bearish pressure being placed on the ZAR's forex performance.

According to the Bank of International Settlements (BIS) Triennial Survey 2019, the ZAR accounts for US$72 billion in average daily forex turnover (1% of the total handle).^[2] While far below the traded volumes of the United States dollar (USD), euro (EUR) or British pound (GBP), the value is enough for the rand to be ranked as a top 20 global currency.

Causes Of Volatility In The South African Rand

Like all other free-floating currencies, the rand's supply/demand curve is constantly evolving in relation to many factors. A few of the most prominent include political unrest, central banking policies, economic performance and outlier events. If any of these underpinnings evolve into a dominant market driver, exchange rate volatility facing the ZAR spikes. The result is a destabilisation of the rand and turbulence in the forex valuations of related pairs.

Political Unrest

For hundreds of years, the continent of Africa has been a hotbed of geopolitical strife. Periodic regime changes, armed conflict and civil unrest have greatly impacted seemingly every African region, including the sub-Saharan. Since its introduction in 1961^[3], the rand has exhibited sensitivity to many such events.

Over the course of its history, the South African political scene has been contentious. For example, the 20th century fight against the aparthied system produced powerful riffs in the social, economic and political environments.^[4] A more recent instance of SA political unrest has come over the issues of land reform and government bailout out of energy producer Eskom.^[5] President Cyril Ramaphosa's pledges to accomplish both have brought political fractures, and in turn, volatility to the ZAR. In the two years following Ramaphosa entering office in February 2018, the rand fell upwards of 20% against the USD.^[6]

Central Banking Policies

One of the key drivers of any currency's value is domestic monetary policy. Ergo, policy decisions regarding interest rates and the money supply are left to a central banking authority. In SA, the South African Reserve Bank (SARB) is the body tasked with maintaining pricing stability and promoting sustainable economic growth.

Typically, when a central bank raises interest rates, the domestic currency is poised to appreciate. Investors acquire the currency in an attempt to secure higher yields, directly reducing the money supply. Conversely, low rates and rate cuts encourage expenditure. This phenomenon is associated with a greater money supply and currency devaluation. For all intents and purposes, any shift in monetary policy is capable of spiking short and medium-term exchange rate volatilities.

The first quarter of 2020 is a prime example of how SARB monetary policy can bring turbulence to the ZAR. On 21 March 2020, the SARB cut interbank lending rates to 3.75%―the fourth such reduction since 1 January 2020. The result of the cuts was a marked devaluation of the rand against global majors. From 1 January 2020 to 1 April 2020, the ZAR lost (21.4%) versus the USD, (20.2%) against the EUR and (16.3%) vs the GBP.^[6]

Economic Performance

Classified as a developing nation, SA's economic prowess is second on the continent of Africa. Globally, SA ranks 30th in terms of GDP, 200th in Unemployment Rate and 39th in exports.^[7] Its leading trade partners are China, the United States and Germany.

Foreign commerce is a complex atmosphere, with the actions of trading partners often threatening domestic economic performance. As a primary trade partner and destination for mineral exports, China's policies can make a big difference to the South African economy. An illustration of this phenomenon came with dramatic changes to China's monetary stance during 2015. A mid-2015 2% devaluation of the Chinese yuan (CNY) by the People's Bank of China (PBOC) produced a 6-month aggregate 26% loss for the ZAR.^[8] Upon growing concerns regarding the future of SA/China trade, the rand slumped on economic uncertainty.

The SA economic is dominated by the services industry, but also is heavily reliant on mining and agricultural production. Due to the importance of gold, platinum, palladium and corn, the ZAR is considered to be a commodity dollar. Should the values of these raw materials fluctuate in the global marketplace, the rand is likely to experience periods of heightened bullish or bearish volatility.

Outlier Events

A true outlier or Black Swan event is one that comes as complete surprise to all involved. It can quickly turn market sentiment, economic performance and forex valuations upside down. Existing as "unknown unknowns," governments and central banks have no concrete guidelines to fight against the negative impacts of Black Swans. This has myriad implications, ranging from severe economic contractions to chaotic asset pricing volatility.

The coronavirus (COVID-19) pandemic of 2020 served to be a Black Swan event that sent global commerce reeling. Unfortunately, the impact on SA was extensive, both economically and socially. Losses in output for sub-Saharan Africa were projected to be severe, falling from 2.4% in 2019 to between -2.1% and -5.1% for 2020. The COVID-19 contagion was to bring on the first regional recession in 25 years.^[9]

Subsequently, the COVID-19 downturn brought scrutiny to SA's national debt load. On 27 March 2020, Moody's Investors Service downgraded the nation's sovereign credit from "investment grade" to "junk."^[10] The immediate impact on the rand was extremely negative as a massive offload of SA government bonds was expected. During the 27 March forex session, the ZAR fell precipitously vs the USD (-1.75%), EUR (-2.70%) and GBP (-4.03%).^[6]

Note: Past performance is not an indicator of future results.

Summary

Over the years, SA has been viewed by the international financial community as having great economic potential. Extensive mineral and agricultural resources regularly attract foreign investors seeking extraordinary capital returns. Strong trade partnerships with China and the United States reinforce the optimism, making SA an opportunistic developing nation.

However, like the currencies of most developing nations, exchange rate volatility has frequently plagued the rand. Despite a hardline stance against inflation by the SARB, severe pricing instabilities have historically ensued. The drivers of each volatile period vary, but they're frequently attributed to lagging economic performance, political unrest and outlier events. Upon one or more of these elements becoming evident, the rand is likely to experience moderate or extreme volatility.