Dennis Dykes: Economist, Nedbank

MONEYWEB, Erika van der Merwe|, 14 September 2006

Tito Mboweni’s comments, the rand’s decline, the current account deficit and import quotas.

MONEYWEB: The rand shed about 10c against the US dollar today. I think it was R7.41. Arthur?

ARTHUR BUCHNER: R7.41 – I think just over R14 to the pound. It broke over R14 to the pound, I think it got to R14.04, then broke back. Everyone thought, oh, it’s a false break, and then it closed above R14. So quite weak.

MONEYWEB: Well, the timing of that rand decline happened to coincide with a speech by Reserve Bank governor Tito Mboweni that warned of the risks to interest rates of the swelling current account deficit. Dennis Dykes is chief economist at Nedbank. Dennis, the speech certainly indicated the governor’s view that rand weakness is simply a process of market adjustment. It’s a mechanism to adjust for that trade shortfall. Is this what economic theory tells us will happen? Will markets sort out trade deficits?

DENNIS DYKES: That certainly is what economic theory suggests. Obviously, we have a very large current account deficit – about 6% of GDP, and the latest trade statistics don’t really suggest that it’s starting to narrow very much. And I think what the governor set out – I wasn’t at the actual speech, but what I’ve gathered is that he actually set out the theoretical case which is absolutely right, but I think the market took it as being a prediction that the currency would come under further pressure, and then of course that the implication would be that it would work its way through inflation and into interest rates.

MONEYWEB: Now Dennis, unlike Arthur, you don’t take short-term trading views. Longer term, what does this mean for the rand?

DENNIS DYKES: Well, certainly while this adjustment takes place and if it’s correct that it’s going to take a while for the current account to actually work down, and the market actually buys that and the focus remains on the current account, one would expect that the rand would remain under a bit of pressure. What’s interesting, though, is that the currency adjustment has been very, very strong this year. We’ve really seen quite a dramatic depreciation, and we’re probably getting into kind of like – and this might be a bit controversial – into slightly undervalued territory on a purchasing power parity basis. But you know, that obviously is the subject of some debate. But we’re certainly not in overvalued territory, where the argument might have been made a few months ago that we were slightly overvalued. We certainly have adjusted very, very rapidly and the question is how much further does it have to adjust. And these things tend to overshoot, of course.

MONEYWEB: Now what is causing this trade shortfall in South Africa? We’ve had the governor warning that rand declines would have inflationary consequences, which in turn would compel the policy maker to raise interest rates. But could one argue that monetary policy had in fact been too lax for too long, thereby allowing domestic demand and therefore imports to take off?

DENNIS DYKES: I think yes. I mean the last two cuts in interest rates were somewhat controversial, because we already had credit move higher, we already started to see the consumer spending – instead of the usual sort of 3.5% extra each year it had leapt up to around about 6%. So the second last was relatively controversial and then the last I think was very controversial, given the circumstances. But the Reserve Bank I think was encouraged by the fact that inflation was very low, as were a lot of other central banks at the time. So they were happy to actually cut interest rates because their inflation forecasts suggested that there wouldn’t be any problems on the inflation front, which is their primary mandate. The danger now is though that, having done that, and with consumer spending having been very, very strong, imports over the last two, three years have exploded. And that I think has taken people somewhat by surprise. And at the same time we’ve had exports not really actually reacting to a very, very strong global economy. And I think there are few stories within that, but one of the ones that’s becoming fairly apparent is that, as domestic demand has exploded, as domestic spending has picked up so rapidly, exporters have actually diverted their attention to the domestic market. So it’s been a case of satisfying local demand and not having excess to actually put out into the export market. So in a strange way not only have imports gone up, but the domestic demand has affected our export potential as well. And there are other factors as well. In the mining sector, for example, the switchover from old-order to new-order rights has held back new exploration and in particular new developments. And then infrastructure itself has also been a problem – ports and rail.

MONEYWEB: So there are structural aspects. We can’t just expect the currency to sort out our problems for us. We do need some structural intervention.

DENNIS DYKES: That’s right. Of course, the currency via higher prices and via higher interest rates could actually help sort out the demand side. But that is not really the adjustment that you’d like to see – you know, where one would actually like to see exports actually adjusting and consequently the current account deficit narrowing or even going positive, at the same time having very strong domestic demand. But given those constraints that I actually outlined, it looks more like what would happen if the markets actually forced the issue, because it really is a question of perceptions of risks if the issue was forced that all the adjustment would take place on domestic demand.

MONEYWEB: Now talking of issues being forced and adjustments, we’ve had the DTI taking the side of trade unions in the textile and clothing sector, saying one way to stop imports is to simply impose quotas. Is this accepted global practice?

DENNIS DYKES: No, it’s certainly not accepted global practice. You know, we’ve had the whole world going towards more levels of free trade. And of course the benefit there is quite obvious. If the consumer actually has much, much lower price to pay for certain goods, then they’ve got more cash to actually spend elsewhere in restaurants, etc, and that boosts employment in other industries. So it is an unfortunate way of actually going about it. And I think even DTI would suggest that it’s a temporary sort of thing. It’s trying to get the industry over a very rough patch, but it can’t be seen as a permanent sort of solution, because clothing and textiles already are a fairly protected sort of area of the economy. They already have had a number of years to adjust to the lower tariffs that were conceded under GATT, for example – the Uruguay round of GATT. So it would be an industry that, unless it adjusts, unless it actually finds its niches very, very quickly, it would be an industry on the decline. And the cost of that adjustment is borne by the consumer. And, as I say, that impacts unfortunately on other industries and on other employment levels in other industries. So it’s not a final solution at all.

MONEYWEB: And it is thanks to Dennis Dykes, chief economist at Nedbank.

Posted in Market commentary

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