At this time, more than even in usual market conditions, it is necessary to focus on basic guidelines rather than possible misplaced hopes for the future.

In Touch (IT) recently caught up with financial services industry leader and Ernst & Young partner Rakesh Garach to discuss what local businesses and investors can do in the face of continued weak exchange rates.

IT: What are your predictions for the future trend in Rand value - stabilising, bottoming out, bouncing back?
RG: The past few years have proved a difficult trading environment for the Rand. The slightest negative rumours tend to impact quite dramatically and harshly on the value of the currency. Indeed, the Rand has depreciated by more than it's inflation differential with its major trading partners over the past five years, which means that in real terms, the effective purchasing power of the currency is weaker each year. Until such time as there are major investment flows to southern Africa, it is going to be extremely difficult to reverse this trend of a declining Rand.

IT: What is the probable range of values the currencies will reach in the short and medium term?
RG: Forecasting the value of the Rand is one of the most difficult variables for economists to predict, and this has been the case ever since the Rand first began depreciating by a larger margin than its inflation differential with its major trading partners. The slightest exogenous shocks impact severely on the Rand, and on the basis of the most recent rates of annual depreciation, the Rand could well hit 10 to the US$ by the end of next year. However, given that Telkom's listing is scheduled to take place during 2002, and other major privatisations may also result in inward directed investment flows, the value of the Rand's scope for further decline may be curtailed. In short, there are too many exogenous factors that can impact on the Rand's value, and the recent terror attack on the USA is a case in point. It resulted in a strong demand for stable currencies, thus further eroding the value of a number of third world currencies.

IT: What are the factors (local and global), which contribute to the Rand being and under-valued currency?
RG: Poor investor sentiment for Africa, lack of clarity from Government on their privatisation policy, the Reserve Bank's Open Forward Book (although much reduced since Tito Mboweni first took over as Governor of the Reserve Bank), the growing movement of hedge funds that have taken speculative forward positions against the currency, contagion effects of emerging economies' debt crises - the Rand was knocked first by the Asian emerging market crisis, and more recently by Argentina. It is clear that terror attacks, and the threat of ware also strongly affect that Rand's value.

IT: How can a local business (not involved in export) protect itself against a deteriorating Rand value?
RG: One means to protecting against a deteriorating currency is to diversify one's earnings stream, and to obtain a greater share of revenue in hard currencies. This may require an upfront investment for an offshore acquisition, but even this in itself is a currency hedge, because as the value of the Rand declines, so the value of the original investment will increase proportionally to the Rand's decline.

IT: What impact does the Rand value have on business involved in import and/or export?
RG: Those industries that require heavy investment in production processes will feel the impact of the Rand's decline most greatly. Particularly, the manufacturing and mining sectors who are either in need of upgrading current infrastructure, or who are looking to build their infrastructure base, will feel the impact more strongly than the less investment-intensive (service) industries which rely more on intellectual capital.

IT: How can a private investor manage his portfolio to avoid forex risk?
RG: There are two options available. One is to invest in Rand denominated offshore funds, which provide for protection against Rand weaknesses. There is currently a wide spectrum of offshore funds available which are denominated in Rand currency, and which therefore provide for a diversified offshore portfolio to be built. The only potential drawback of this option is the limits placed on local fund managers, who are restricted to placing a maximum of 10% of the previous year's inflows into offshore investments. The second approach requires making use of the R750k allowance, which each individual investor is allowed to move into offshore investments. This provides a far larger universe of investment possibilities, and although many international fund managers may not market directly to the South African public without Financial Services Board authority, a large number of global companies have gone the route of seeking the relevant authority. Hence their products are freely available through independent brokers and/or local representative offices.

IT: To what extent has volatility or the prospect of a bear market driven corporate or private investors towards traditionally "safe" options?
RG: South Africa has witnessed weak equity markets since the latter 1990's, with the advent of the emerging markets crisis precipitating a new bear phase. With the exception of the resources sector, which has largely exceeded expectations ever since, the local bourse did not reflect a positively growing equity market. Therefore, it is not surprising that local investors began switching into income and bond funds and increasingly away from local equities, although to some extent, this was symptomatic of local investors having access to offshore investment funds for the first time. Now that global equity markets are looking bleak in terms of investment performance, there has been an even stronger preference for non-equity investments, namely bond, income and money market funds. The recent US terror attacks are likely to feed negative sentiment for a while to come, although the speed at which the American bourse has recovered since September 11, indicates that global investors are not excessively pessimistic. Nevertheless, there are industries such as airlines and tourism, which will pull the overall equity market's performance down during the short to medium term.

Source: Rakesh Garach, Financial Services Partner, Ernst & Young, (011) 772-3038.

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