Has the Rand brand lost some of its shine?

Is the Rand still the darling of the EM space?

A question that has come up in the past few years is, whether the Rand is still the darling of the Emerging Market (EM) space? It has been well noted in the past that the Rand was used as a proxy for the EM basket of currencies, as the market normally cited the ease of moving funds in and out of South Africa, as the main reason to use South Africa as a vessel to have some exposure to EM risk in their portfolios.

Another reason why the market used the Rand as a proxy hedge was the so called “carry trade”. A carry trade is an investment strategy where an investor borrows money in a currency with a low interest rate and invests in another currency that offers a higher interest rate. The investor does so with the aim of profiting from the interest-rate differential between the two currencies. With the South African interest rates being higher than some develop countries it made sense to make use of this interest differential.

However, carrying this moniker as being the proxy currency comes with a price, and chief among this is that volatility in a proxy currency is normally more pronounced than the underlining EM currencies. This was easy to witness in the past with the Rand always overshooting its peers when there was a bout of EM weakness or EM strength. This brings us to the crux of the matter, has the Rand lost some of its shine against other EM peers.

The first measure to test the carry trade theory is to see the movement of the Rand against its EM peers and to see whether it holds true the EM currencies should move in unison with the Rand being a little more volatile but the trend should be observable. The graph below shows the Rand versus the Mexican Peso. The Peso also has a interest rate similar to the Rand and if the Rand has lost some of its shine there should be a significant divergence between the two currencies.

South African Rand vs Mexican Peso

The above clearly shows that the two currencies tracked each other quite closely up until July of 2022, where the Peso started to trade significantly stronger than the Rand against the US dollar. One of the biggest reasons for this has been the fact of the gray listing of South Africa, which did have an impact on the attractiveness of the Rand and another reasons is the law that was passed where asset managers could assign a greater portion of their investments to off shore assets.

South African Rand worst performing currency

To illustrate the point further, from the above chart we can see that the Rand has been one of the worst performing currencies in the world in the past five years, where the Mexican Peso was one of the best performing against the US dollar.  Looking at the worst performing currencies one can discard the Lira and the Argentine Peso as they have fundamental economic issues that are far greater than any other country on the list.

This shows by how much the Rand has retreated against the Mexican Peso and taking a look at the countries side by side there is not a lot of difference. The only major difference is the amount of red tape that increased in South Africa, and that shows the fickle nature of investors as they always take the path of least resistance.