The effect of a declining Rand exchange rate on the SA soft flooring industry
The current situation of a declining currency in South Africa has effects on all facets of theSouth African economy. Some are positive, some are negative, but of importance is the fact that a sudden decline has major implications for planning.
South Africa’s currency decline will change in the future, but the question is when,” says Oscar Grobler, Chairman of Avance Carpets (Pty) Ltd. Some economists and traders predict that the Rand will stabilise this year and that it could even appreciate in value. Some are saying that it will decline further, quoting figures of R18 or even R20 to the US Dollar by calendar year end 2016. All agree it will reverse, but at different times and all agree the level to which it will appreciate to, is speculation. Using the “Big Mac” price Index, the Rand is 66% undervalued to the US Dollar without taking differences in labour costs into consideration (GDP per capita index) and 39% undervalued when taking the aforementioned into account.
“The flooring industry (like many other industries) has to plan and strategize on the way forward,” Oscar continues. The one component businesses all seek is consistency. So when the Rand has a sudden 10% or more depreciation in the space of 24 hours, businesses seek a solution to the problem. Forward cover, foreign currency options and the like offer temporary reprieve as working capital requirements have a maximum duration of six months. Capex plans take on a different meaning as the models did not take into account such violent moves. Payback periods are extended, cost of capital escalate and shareholders say risk reward scenarios do not compel them to invest. Another option is looking for alternative products to sell, but in many cases these, too, need to be imported.
“So where to from here?” asks Oscar. There are several scenarios that can be spelt out but “percolating” through this haze emerges two words: “Plan and Strategize”. That is what needs to be done and these two words call for understanding the risks the soft flooring industry face and to evaluate the strategic importance of importing machinery so as to manufacture locally and to evaluate this against the advantages/disadvantages of importing the finished product against the backdrop of a volatile and declining exchange rate.
The effect of the declining exchange rate therefor is to force business to understand that the risk becomes untenable if you are not in adequate control of your costs of sales. The models that were formulated to show the “worst case” scenarios have to be re-written to show the new found variables. The forex exchange variables now used in all cost models have levels that have not been seen before and hence the confidence of business people topredict what the year ahead looks like is at a record low.
Again it is the unknown that worries business and although it is said where there is risk there is reward, the quantum of what is acceptable risk is now up for debate. “The sudden decline the country has experienced with its currency is to not an acceptable risk,” concludes Oscar. “One of the solutions to this risk profile is to manufacture and buy locally. In this way the country keeps its work force employed, we grow the economy and we pay our taxes. Surely ‘Local is Lekker’!”
Oscar Grobler, Chairman of Avance Carpets (Pty) Ltd