As an exotic currency, the South African rand (ZAR) has been historically sensitive to world events. One of the primary reasons behind the rand's responsiveness is the lack of consistent market depth. When compared to the global majors and minors, the ZAR typically exhibits a much smaller daily traded volume. According to the Bank of International Settlements (BIS) Triennial Survey 2019, the South African rand accounts for 1% of total average daily forex turnover (US$72 billion). This ranking places the ZAR on par with the Turkish lira (TRY), Brazilian real (BRL) and Russian ruble (RUB).
The combination of limited liquidity and domestic economic instability make the ZAR vulnerable to volatility stemming from world events. A prime illustration of this phenomenon came with the onset of the coronavirus (COVID-19) pandemic of 2020. During March 2020, the rand depreciated by more than 12% against the euro (EUR), United States dollar (USD) and Swiss franc (CHF). Although a prolonged rally in gold (XAU) from April to December 2020 helped support the rand, pricing fallout from COVID-19 proved substantial.
Ultimately, the rand's small float and South Africa's narrow economic diversity both serve to magnify the impact of global events on the ZAR. From a practical standpoint, any happenings that trigger a global downturn, economic boom or a humanitarian crisis typically have a profound impact on rand valuations.
Global Economic Expansion And Foreign Investiture
During periods of global economic expansion, emerging countries are well positioned to experience significant growth. As the prosperity of developed nations increases, the risk appetite of global investors also increases. This sets the stage for a spike in foreign direct investment (FDI) toward riskier, emerging economies.
The Organisation for Economic Co-operation and Development (OECD) defines FDI as follows:
"Foreign direct investment is a category of cross-border investment in which an investor resident in one economy establishes a lasting interest in and a significant degree of influence over an enterprise resident in another economy."
FDI comes in various forms, with the most effectual being capital that is allocated to infrastructure development, commodity extraction or corporate acquisitions. For South Africa, as well as most emerging economies, foreign investiture is an important driver of economic development. Essentially, as the risk-appetite of international investors expands, investment revenues grow in South Africa. The results are often positive for the rand, normally driving valuations higher.
The relationship between increasing FDI and a rising ZAR is evident during the expansionary period of 2016 to 2019. During this time, global equities posted significant gains, led by performance of the CAC 40 (+28.9%), DAX 30 (+34.8) and Dow 30 (+60.9%) indices. The result was an international risk-on attitude, which grew FDI in South Africa consistently:
- 2016: US$2.215 billion
- 2017: US$2.059 billion
- 2018: US$5.569 billion
- 2019: US$4.625 billion
Subsequently, for the period of 1 January 2016 to 2 December 2019, the South African rand performed admirably versus the global majors:
- ZAR/EUR: The rand appreciated steadily against the euro, gaining 4.2% for the period.
- ZAR/USD: Versus the USD, the ZAR posted a 5.7% three-year rally.
- ZAR/GBP: The rand turned in a robust performance vs the GBP, rising 20.3%.
- ZAR/CHF: Against the traditional safe-haven Swiss franc, the ZAR ticked higher by 5.1%.
- ZAR/CAD: In the exchange of two commodity dollars, the ZAR posted a modest 1.4% gain vs the Canadian loonie.
Note: Past performance is not indicative of future results.
Although the ZAR remained an exotic currency with limited traded volumes, rates against the forex majors held firm. The increased FDI brought on by global economic expansion promoted positive sentiment toward the rand and boosted valuations.
ZAR Volatility Spikes During The COVID-19 Pandemic
The early portion of 2020 brought a nearly unprecedented world event―a global pandemic. Labeled "COVID-19," the contagion brought widespread lockdowns, quarantines and travel bans. The economic fallout was dramatic in nearly all locales as governments and central banks took bold steps to mitigate COVID-19's damage.
Among the hardest hit countries were those classified as "emerging" or "developing." According to statistics from the United Nations (U.N.), more than 34 million people were expected to be pushed into extreme poverty during 2020 with many residing in developing nations. In addition, U.N. figures indicate that the poverty rates for workers in Africa increased by 62% for the month of March 2020. The increase was a sign of a severe economic contraction created by reduced consumption, lagging demand for exports and the postponement of planned investitures.
The shock of COVID-19 came on several fronts for Africa. Among the most notable were extremely low commodity prices, the elimination of tourism and vastly reduced FDI. For the continent of Africa, FDI was projected to plummet between 25% and 40% for 2020. This reduction was poised to slow the development of commodity-based projects, greatly impacting regional future growth prospects.
As expected, the negative fallout from COVID-19 on South Africa was severe. On a year-over-year basis, South African GDP fell by -17.5% (Q2) and -6.0% (Q3) 2020. Despite the dismal GDP figures, late-2020 brought optimism as gold prices remained strong and concerns over future lockdowns eased.
Periods Of Volatility During 2020
Given the confluence of COVID-19 and various other factors, the ZAR experienced several periods of extreme volatility throughout 2020. On an annual basis, the rand ended the year significantly down against the forex majors:
- ZAR/EUR: COVID-19 fallout was severe against the EUR as the rand lost 12.5%.
- ZAR/USD: The ZAR fared negatively against the USD, losing 4.2% for the year.
- ZAR/GBP: Rand valuations slumped by 6.6% vs the British pound sterling.
- ZAR/CHF: The pandemic provided an abundance of bullish sentiment toward the Swiss franc, sending the ZAR/CHF 12.2% lower.
- ZAR/CAD: A late-year rebound in crude oil spurred a Canadian dollar rally of 5.8% against the ZAR.
Note: Past performance is not indicative of future results.
Unfortunately for the ZAR, the global economic downturn brought on by COVID-19 hurt valuations across the board. Nonetheless, should FDI improve, commodity prices gain strength and COVID-19 come under control, the ZAR could regain forex marketshare.
As an exotic currency, the South African rand has historically exhibited a sensitivity to world events. During periods of global expansion, an increase in foreign investment has spurred economic growth and valuations of the ZAR. Conversely, crises such as the COVID-19 pandemic have proven detrimental to the rand.
Ultimately, underpinnings such as global monetary policy, FDI and commodity prices are premier market drivers of the South African rand. Any world events that influence these factors, either positively or negatively, can have a profound impact on ZAR valuations across the forex.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…