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Prepared by: SEOKE L. J. ASSIGNMENT TOPIC: a weak currency or a strong currency for the South African economy? What are the pros and cons of a weak currency or a strong currency in South Africa? Discuss. A. Introduction Cartoonists in South Africa have a long-running joke that shows a bruised and feeble coin, the rand, being beaten up by two muscled thugs, the dollar and the pound. In 2001 South Africa’s currency was knocked down by two-fifths against the greenback, much of it in the closing weeks of the year. [The Economist (Jan 17th 2002)] Turnbull, Jdefines currency as something that is used or accepted by a lot of people.
Looking at the definition in economic terms it can be explained as the system of money that a country uses. A currency with value that has depreciated significantly over time against other currencies is distinct as weak. The long-term outlook for a weak currency is that it will continue to lose value due to fundamental weaknesses in the nation that issues this currency. A weak currency is a currency said to be a less desirable form of payment than other currencies. These currencies generally trade at a discount in relation to currencies of economically developed countries.
Foreign exchange dealers generally do not make markets in weak currencies, except for currency speculation. A dealer who expects a weak currency to decline in value may sell that currency short, making a profit from the difference in exchange rates. Acceptability of one currency versus another is dependent, of course, on local market conditions. The Portuguese escudo, for example, may be a weaker currency than the U. S. dollar, but its relative weakness may not be significant enough to discourage exporters from accepting it as payment.
On the other hand a currency is strong when it is worth more relative to other currencies. This is because most currencies are floating, their values vary according to market trends. When one unit of a currency trades for more units of another currency, it is known as a strong currency. [Farlex Financial Dictionary. 2009] Strong currency is currency that lenders are willing to accept as payment, other than their own national currency. Also, a convertible currency trading in the exchange markets at a premium vis-a-vis other convertible currencies.
Lenders have no legal obligation to accept payment in a strong currency. Central banks maintain a portion of their reserves in strong currency deposits. A strong currency is also known as a reserve currency. Most countries of the world have their own currencies: The United States has its dollar, the European Monetary Union as it euro; Brazil, its real; and china, its Yuan. Trade between countries involves the mutual exchange of different currencies. Mishkin (2010: 433) assert that “When an American firm buys foreign goods, services or financial assets, for example, U. S. ollars must be exchanged for foreign currency. ” The South African currency is the South African rand (ZAR). The Rand is the legal tender and official currency of South Africa. The Rand was introduced in 1961 with the establishment of the Republic of South Africa, supplanting the South African Pound as legal tender at a rate of 2 Rand per Pound. One Rand can be divided into 100 cents. The Rand is available in banknotes of 10, 20, 50, 100, and 200 Rand denominations. It is also available in 9 coins in 1c, 2c, 5c, 10c, 20c, 50c, R1, R2, and R5 denominations. [Go Currency, 2009]
B. Economics overview Since becoming independent, South Africa has developed into a middle-income, emerging market with an abundant supply of natural resources; well-developed financial, legal, communications, energy, and transport sectors, a stock exchange that ranks among the ten largest in the world, and a modern infrastructure supporting an efficient distribution of goods. However, growth has not been strong enough to alleviate South Africa of a high unemployment rate and other economic problem like poverty and lack of economic empowerment among disadvantage groups.
South Africa’s economic policy has focused on targeting inflation and liberalizing trade with aims of increasing job growth and household income. [Go Currency, 2009] “The rand is still performing fantastically well although it has weakened from the (strong levels) we saw at the end of last year, but that’s largely due to the thin liquidity that we’ve seen,” Bidvest Bank chief dealer Ion de Vleeschauwer said in an interview with IOL. co. za, January 06, 2011 With a keen ear, South African accents may be notice more in New York or London shops these days.
The rand has risen by roughly a quarter against a basket of currencies in 2003. Against the dollar, it is up by a third. Two years before a dollar bought 11 or 12 rand (and briefly more than 13); lately it has been fetching six and a bit. For the rand’s rally, thank not only the weak dollar but also strong prices for gold and platinum exports, and high South African interest rates. [The Economist (Jan 17th 2002)] South Africa’s rand has made massive gains against the weak U. S. dollar, currently trading at about 7. 23 rand, compared to a low of 11. 07 during the global financial crisis in 2008.
For South Africa, the debate seesaws between those who seek action to tame the rand and those who see the strong currency as a blessing. [The China Post, 2011] C. What are foreign exchange rates? The currency of a country has to be valued in relations to another currency. In most circumstances, global currencies are widely quoted against two major currencies in the world: the U. S. dollar and the euro. However, most countries also quote their national currencies against currencies other than the dollar and the euro; these are known as currency cross rates, (Mishkin, 2010: 434) D.
Unanticipated decline in the value of the domestic currency For the reason that of hesitation about the forthcoming value of the domestic currency in developing countries, many nonfinancial firms, banks, and governments in developing countries find it easier to issue debt denominated in foreign currencies rather than in their own currency. This can lead to a financial disaster in a similar fashion to an unsuspected decline in the price level. With debt bonds denominated in foreign currency, when there is an unanticipated decline in the value of the domestic currency, the debt burden of the domestic firm rises.
Mishkin (2010: 200) advocate thatsince assets are naturally denominated in domestic currency, there is a resulting deterioration in firms’ balance sheets and a decline in net worth, which then increases adverse selection and moral hazard problems. E. Advantages of a weak currency While a temporarily weak phase in a major currency provides a pricing advantage to its exporters, such a benefit seldom accrues to exporters in weak currency nations, since other factors such as high input costs and bureaucratic red tape may offset this advantage. Investopedia] When a country’s currency depreciates, its goods abroad become cheaper and foreign goods in that country become more expensive. Depreciation of a currency makes it easier for domestic manufactures to sell their goods abroad and makes foreign goods less competitive in domestic markets, (Mishkin, 2010: 436) Other advantages * South African firms find it easier to sell goods in foreign markets * South African firms find less competitive pressure to keep prices low * More foreign tourists can afford to visit the South Africa * South African capital markets become more attractive to foreign investors
F. Disadvantages of a weak currency Weak currency nations generally have poor economic fundamentals, which may include a high rate of inflation, chronic current account and budget deficits, and sluggish economic growth. Nations with weak currencies usually have much higher levels of imports, compared with their exports, resulting in more supply than demand for such currencies on international foreign exchange markets if they are freely-traded currencies. Investopedia] Weak currency countries have frequent currency devaluations against currencies of major trading partners, balance of payment deficits, or political instability Other disadvantages * Consumers face higher prices on foreign products/services * Higher prices on foreign products contribute to higher cost-of-living * South African consumers find traveling abroad more costly * South African firms and investors find it difficult to expand into foreign markets G. Advantages of a strong currency
When a currency is strong, travellers are able to go abroad while spending less of their money. A strong currency can be disinflationary for currencies pegged to it. “In the last 10 years, when the rand has strengthened, we’ve experienced higher economic growth and lower inflation,” said Hart, adding that a stronger currency also helps to attract skills. A strengthened currency does hurt exporters, but many exporters also import so the effects are tempered. Imports can be bought cheaply when the rand is strong, said Ebrahim-Khalil Hassen, an independent South African economist.
For South African farmers, most of the big-ticket equipment such as tractors and hay machinery are imported, so a strengthened rand is beneficial, said Dr Jim Rankin, secretary of a South African agricultural machinery trade association. In addition, South Africa, hoping to continue drawing foreign tourists long after the World Cup, may not be hindered by the strengthened currency because it reduces the cost of getting to South Africa in terms of airfares, Hart said. Other advantages Consumer sees lower prices on foreign products/services * Lower prices on foreign products/services help keep inflation low * South African investors can purchase foreign stocks/bonds at “lower” prices. For example Asian investors took advantage of the deteriorating value of the U. S. dollar during June and August 2011 by more buying U. S. stocks than usual. H. Disadvantages of a strong currency Advocates of the weak currency argue that South Africa’s strong currency is uncompetitive and hurting the country’s exporters and local producers, Trade Minister Rob Davies said Tuesday. There’s a consensus that at this level, where the rand is now, the rand is uncompetitive and is having a detrimental effect not only on exporters but also on local producers who are suffering unfair competition from imports,” he said. [The China Post, 2011] When a country’s currency appreciates, the country’s goods abroad become more expensive and foreign goods in that country become cheaper. Appreciation of a currency makes it difficult for domestic manufacturers to sell their goods abroad and makes foreign goods more competitive in the domestic market (Mishkin, 2010, 436)
South Africa’s currency is trading at an almost three-year high against the US dollar, raising concerns about how strong is too strong. That puts it in a similar category as several other countries, such as Japan, that are wrestling with a soaring currency. But South Africa finds itself in a unique position. While the government is under pressure to rein in the strengthening currency because it is hampering exports and perpetuating unemployment, the strong currency is also pushing economic growth in one of Africa’s biggest economies.
South Africa’s peculiar situation comes as currency issues move to the forefront of global debates about the balance of trade, with some observers raising the prospect of ” currency wars”. Unions fear a too-powerful South African rand could deter efforts to drive down the country’s 25% unemployment rate. “In a world market where wealthier countries have massive protectionist measures in place, developing countries have to take exceptional measures to develop their industries,” said Patrick Craven, spokesman for South Africa’s biggest trade union federation, Cosatu.
Reducing the value of the rand is one way of doing that. In a budget speech earlier this month, South Africa’s finance minister said the country will focus on building its foreign exchange reserves and lowering debt to slow the strengthening currency. While South Africa’s recently lowered interest rates have boosted the economy, currency overvaluation can threaten jobs and widen the deficit, Pravin Gordhan said. He said the rand exchange rate is about 12% above its average level for the past decade. The dollar began a broad decline in early summer.
Against the rand, it is down about 18% since late May and was worth about R6. 80 on the 8th of November 2010. The US currency first dropped below R7 in September, for the first time since January 2008. below R7 in September, for the first time since January 2008. Other disadvantages * U. S. firms find it hard to compete in foreign markets * U. S. firms must compete with lower priced foreign goods * Foreign tourists find it more expensive to visit U. S. * More difficult for foreign investors to provide capital to U. S. in time of heavy U.
S. borrowing J References 1. Farlex Financial Dictionary. 2009 Farlex, Inc. All Rights Reserved] 2. Go Currency (2009). What is the South African rand (ZAR)? Go Currency[Date accessed: Aug 24th 2011 on:http://www. gocurrency. com/countries/south_africa. htm] 3. Mishkin, F. S. (2010). The Economics of Money:Banking and Financial Markets. 9th edition. USA:Pearson Education Inc. 4. The China Post. (April 21, 2011 ). South Africa’s trade minister warns against strong currency. The China Post. [Accessed date: Aug 11th 2011.
On: http://www. chinapost. com. tw/business/africa/2011/04/21/299539/South-Africas. htm 5. The Economist (Jan 17th 2002). South Africa’s weak currency. No random walk: Interest rates up, an inquiry launched. The Economist. [Date accessed: Aug 22nd 2011. on:http://www. economist. com/node/941460] 6. Turnbull,J (2010). Oxford Advanced Learner’s Dictionary. 8th. UK: Oxford University Press 7. Van Der Merwe, M. (2010). Monetary Economics in South Africa. Cape Town: Oxford University Press Southern Africa.