There are many theoretical frameworks that can be used to define the underlying equilibrium value of the exchange Rate at different horizons. The chart below plots implied Fair value estimate from a model that incorporates inflation and interest rate differentials. The model suggests that the ZAR is 13% undervalued against the USD at present, 13% against the EUR and 10% against the GBP.

The estimates from our model are broadly in line with the SARB’s recent assessment. The SARB provides projections of the nominal effective exchange rate and their latest forecasts (from July 2023) imply that the rand was undervalued by around 12% on a trade-weighted basis at the time of their forecasts. Their projections also assume that this undervaluation is not expected to be eliminated this year.

Fair value models often produce less accurate forecasts than statistical forecasting models, but they can still be useful in describing the level of the currency consistent with economic and financial fundamentals. Since the ZAR often appreciates/depreciates after bouts of sharp depreciation/appreciation and fair value estimates can help detect long term mean reversion in exchange rates. Codera will be launching an FX forecasting service, contact us if you are interested in subscribing to FX forecasts.

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