The trouble with exports

The South African rand trades at about R 7.70 to the US dollar.  This rate implies that, if you travel to another country, whatever you buy there should cost the same as you buy locally, when you account for that exchange rate.  Anyone who has travelled overseas knows that this isn’t so.

An exchange rate is not the whole story. 

The Economist, a financial journal, quantifies this difference in a tongue-in-cheek parody called The Big Mac Index.  All things being equal, a McDonalds Big Mac burger should cost the same around the world.  By looking at the difference in prices relative to exchange rates, they can give an index of the measure to which a currency is over- or under-valued.  Clearly this isn’t perfect, but it is a proxy for the more generally used (and complex) measure of Purchasing Power Parity (PPP).

According to the latest Big Mac Index, the eponymous burger costs $2.17 here and $ 3.57 in the US.  This means that the rand is undervalued by about 39%.  Surprisingly, this ties in exactly with the current estimates of both the World Bank and South Africa’s Reserve Bank.

The implication is that – our experience of high inflation aside – products in South Africa are 39% cheaper than they are in the rest of the world.  Conversely, it means that whatever we buy from the outside world should be terribly overpriced.

This should be tremendously good for exports and bad for imports.  Precisely what any thriving emerging market could hope for.

The leading emerging markets all find themselves in a similar position.  China’s currency is 49% undervalued, South Korea’s 28% and Malaysia’s 47%.  These countries all tend to run current account surpluses; their exports exceed their imports.  This creates jobs, further investment and rising standards of living.

South Africa is not in this club.  Imports dramatically exceed exports by over $18 billion a year; some 5.8% of GDP.  Worse is to come.

As the economy slides deeper into recession, one expects that imports would decline.  And they are.  The Reserve Bank reports that imports fell 3.2% in the first quarter of 2009.  But exports fell too.  The Producer Price Index – inflation experienced by manufacturers – is falling as well; now at -3%.

This is not a good situation.  Consumers may heave a sigh of relief, but falling factory prices will result in reduced investment, decreasing production and massive job losses.  The fall in exports, as well as the slow decline in the overall economic growth rate, says that this is starting to happen already.

There is something wrong.  An undervalued currency implies that investment should return good rewards to foreigners.  Yet, there is a net exodus of capital from the country.

One doesn’t have to look far to see why.  At the large investor end, government is yielding to the Communist fringe of their party, and is promising to re-open the debate on nationalisation of mining.  The industry is South Africa’s biggest exporter.  The private health sector is threatened with price controls and nationalisation.  Many of these companies, having moved their primary stock exchange listings off-shore, are gradually moving their primary investments elsewhere as well.

At the small-business end of the economy – the real engine of job creation – we are once again in the midst of xenophobic attacks against entrepreneurial foreigners.  Strikes and industry-mandated minimum wage agreements drive up the costs of employment and many marginal businesses are shutting down.

The economy is at a crisis point.  The response from government has been to buy new cars and hope for the best.  That frustration with the failure of government to deliver on their promises is boiling over in the impoverished townships is understandable.

That this frustration is being used to target foreign investors – no matter how small – is troubling.

The credit crisis has changed many things, but the need for sustained investment is not one of them.