RAND SETTLES DOWN IN 2005

UNCLAS SECTION 01 OF 02 PRETORIA 005009

SIPDIS

SIPDIS

DEPT FOR AF/S/MTABLER-STONE; AF/EPS; EB/IFD/OMA
USDOC FOR 4510/ITA/MAC/AME/OA/JDIEMOND
TREASURY FOR OAISA/JRALYEA/BCUSHMAN
USTR FOR PCOLEMAN

E.O. 12958: N/A
TAGS: ECON EINV EFIN ETRD BEXP KTDB PGOV SF
SUBJECT: RAND SETTLES DOWN IN 2005

REF: A) PRETORIA 1959, B) PRETORIA 4936


1. Summary. In 2005 the South African rand has shown less
volatility than in the previous three years, prompting
speculation that the rand will settle around a relatively
narrow range of R6.35-6.70 per dollar for 2006. Increased
liquidity has helped, with the average daily turnover in the
country's foreign exchange market has increased from $3.8
billion in the first quarter of 1998 to $13.8 billion in the
third quarter 2005. Improved credit ratings and growth
prospects have also helped stabilize the rand, along with
increased foreign direct investment in 2005. Monetary
policy has kept inflation under control, with the consumer
price index measure monitored by the South African Reserve
Bank within its 3% to 6% target range for 27 straight
months. With commodity prices expected to remain high and
growth prospects favorable, the rand should become more
stable, perhaps attracting even more foreign investment.
End Summary.

Rand Instability: Is it History?
--------------


2. The South African rand has lost about 12 percent against
the dollar in 2005 to date, its first depreciation over a
calendar year since 2001 and a relatively mild move after
three straight years of hefty gains. In 2002 it increased
40% against the dollar, in 2003 it added 28% and last year
it increased another 18%. The rand's swings have also
moderated recently. In 2005 it ranged between a high of
5.617 to the dollar, reached early in January, to a low of
6.977 in June, a difference of 136 rand cents. In 2004 its
range was about 200 rand cents, in 2003 almost 300 rand
cents and in 2002 it was 410 rand cents. In December 2001,
when it sank to 13.84 to the dollar, the currency was
extremely volatile, gaining around 200 rand cents alone in
the last 10 days of the year. In 1998, when the Asian
currency crisis hit, the rand's range was only 200 rand
cents between its high and low, illustrating that 2005 might
be the beginning of a stable rand.

Increased Liquidity
--------------


3. Increased liquidity has helped the rand to stabilize.
According to the South African Reserve Bank (SARB),the
average daily turnover in the country's foreign exchange
market has increased from $3.8 billion in the first quarter
of 1998 to $13.8 billion in the third quarter of 2005. In
fact, the rand is the most actively traded emerging market
currency. Some of this increase may be due to speculation
as growth in trade and the economy, while brisk, has not
matched growth in foreign exchange liquidity. Moreover, the
increased size of the market has made it more difficult for
speculators to dramatically influence the value of the rand.
In the past, the rand has been most erratic when trading is
low.


4. Deepening liquidity also points to growing confidence in
a well-managed economy. Fiscal deficits have remained low
and inflation targeting has kept interest rates within the
3% to 6% targeted range for the past 27 months. Since 2000,
the deficit to GDP ratio has remained below 2.5%, reaching
2% by year's end in 2004. In the third quarter 2005, it had
reached 1.5%, due to higher than expected revenue
collection.

Better Growth Prospects
--------------


5. The rand has stabilized recently, even though current
account deficits are on the increase. The ratio of current
account deficit to GDP has steadily increased from -1.3% in
2003 to -4.7% in the third quarter 2005 (all quarters in
2005 have been above -3.7%). Better growth prospects in
2005 have attracted foreign inflows. Increased foreign
direct investment inflows have included British bank
Barclays purchase of a controlling stake in local bank ABSA,
worth over $4 billion and British cellular group Vodafone's
50% purchase of South African cell phone provider Vodacom,
worth $2.4 billion (Reftels). In August 2005, international
ratings agency, Standard & Poor's, upgraded South Africa's
currency, putting South Africa's ratings at BBB+, one notch
below the A category. Moody's upgraded South Africa's
credit ratings in January 2005 and Fitch has put South

PRETORIA 00005009 002 OF 002


African on positive ratings watch, indicating that an
upgrade could come later.


6. Commodity prices have remained high in 2005 and should
remain high. The gold price reached $500 in early December
and in recent trading remains above $500. South Africa's
economy is expected to grow by 5 percent in 2005 after
expanding 4.5 percent in 2004. The South African government
wants to double the long run growth rate from 3% to 6%.
Detailed plans on how to achieve this should be released in
January 2006. However, current demand trends should support
GDP growth over 4%. Both consumption and investment show
strong gains. In 2004, growth in household consumption and
capital formation reached 6.5% and 8.8%, with third quarter
2005 growth at 6.1% and 7.1%, respectively. The black
middle class has grown by 30% in the past 12 months,
increasing the black's population share of South Africa's
middle class to almost one third, according to the 2005 All
Media and Product Survey. Between 1993 and 2003, though the
demographic composition of the population remained the same,
black household's contribution to total household
expenditure increased from 36% to 46%, making blacks the
country's biggest consumer base. Consumer demand growth
prospects remain good.


7. Comment. Currency stability remains important for
foreign investors. Up to now, most foreign investment has
been portfolio inflows, although direct investment in South
Africa has increased substantially over the past year. High
commodity prices, improved growth prospects, increased
foreign liquidity and improved credit ratings have all led
to a more stable rand in the past year. To achieve a 6%
long run growth, South Africa needs more foreign direct
investment and a more stable rand can only help.

TEITELBAUM