A weaker rand: its effect on farmers

There is no consensus among economists about how farmers will be affected if the rand continues to devalue.

Global farming - Dr Koos Coetzee

On 11 January, the rand reached an all-time low of R16,88 to the US dollar. At the time of writing, the value had improved slightly to between R14,50 and R15,50. Economists are divided on the future value of the rand or the effect that the weaker rand will have on farmers.

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The group that takes part in the Economist of the Year competition estimates a value of between R13,95 and R20 to the dollar for the last quarter of 2016, with a consensus estimate of R15,90.

If you ignore the extreme spikes caused by global crises, the long-term trend shows that the rand devalues by about 8% per year.

Why is the rand weak? The price of a currency is determined by supply and demand. As the price is expressed in terms of another currency, the supply and demand of that other currency also influences the price. If inflation in South Africa is higher than in the US, the value of the rand decreases.

If our interest rates are higher than in the US, our markets attracts more money from the US, and demand for the rand will increase, resulting in a strengthening of the rand. However, there is an important proviso. International investors will only invest in riskier markets if the expected returns include a risk premium based on their perception of the safety of their investment.

The credit grading agencies play a major role here, and the threat of a downgrade to junk status for South Africa could see a huge outflow of investment from the country and a weaker rand.

The rand-euro exchange rate shows the same trend as the rand-US$ exchange rate, indicating that the same factors probably influence both exchange rates.

Money supply
The total money supply also plays a role. An extreme example of the effect of increasing the money supply on the value of the currency was seen in Zimbabwe where Z$100 000- and even Z$1 000 000-notes had to be printed. In South Africa, growth of the broadly defined money supply (M3) accelerated to 10% in the second half of 2015 and has since remained firmly above 10%. This will also weaken the value of the rand in future.

A weaker rand benefits export industries, such as the fruit and wine sectors. It also benefits export-vulnerable industries, such as dairy, meat and grain. In the case of the latter, the specific effect depends on whether the devaluation is caused by the rand weakening or by the dollar strengthening.

If it is caused mainly by a stronger dollar, the Chicago Board of Trade (CBOT) prices that form the basis for South Africa’s export and import parity prices adjust to the changed value of the dollar and cancel the effect on rand-based import and export parity prices.

The current devaluation of the rand is largely caused by rand weakness, and has already resulted in much higher grain prices. On the other hand, the weaker rand has a negative impact on intensive livestock industries, which face sharp increases in grain prices, while product prices are slow to increase. In addition, imported consumer goods are more expensive.

Interest rates
Consumer price inflation is already firmly anchored above the Reserve Bank’s 6% upper target limit. The bank is highly likely to increase interest rates in the coming months in an attempt to limit inflationary pressure and, as a secondary goal, to bolster the value of the rand.

Higher interest rates will hit farmers who have to repay production loans from the drought period. For all farmers, a weaker rand means higher input prices. Although the value of the rand may recover somewhat, input prices tend to stick at the levels reached when the rand devalued.

As the rand is more likely to be weak in future, farmers have to use the tools provided by the free market, such as futures markets, to limit the risk of adverse conditions threatening a farm’s sustainability.