Rand Identity

South African wines are enjoying a surge in popularity, though its wine exporters have been wrong-footed by wild currency fluctuations. Joanne Hart reports

SOME NINE per cent of all the wine drunk in Britain comes from South Africa.  Its popularity has risen sharply over the past two years and in 2002, South African wine imports to the UK grew faster than those from any other country.

Not surprisingly, winemakers are keen to capitalise on such success.  Yet this growth in demand comes against a backdrop of intense currency volatility and acute unemployment.  This time last year, there were more than 16 rand to the pound. 

Today, that figure has fallen to just over 12. In other words, the currency is 25% stronger now than it was 12 months ago. Such a move has big implications for all South Africa’s export businesses – and the wine industry is one of the biggest exporters in the republic.

"The currency is extremely volatile. In 2001, the rand deteriorated sharply and that helped exports in 2002 but in the second half of last year, the situation reversed and in late March, the rand hit a two year high," says Matthew Vogel, South African economist at Barclays’ investment banking arm, Barclays Capital.

The strength of the rand can in part be attributed to South Africa’s own economic situation. However, it is also due to factors affecting the rest of the world.  "The rand appreciated largely because of the interest rate differential with other countries and also because the dollar and the euro have been weak lately.

 There is some recognition too of the steps being taken within South Africa to improve its economic position," says Philip Shaw, group economist at South African finance house Investec.

In other words, part of the reason that there are more rand to the pound this year than last stems not from the rand’s particular strength but from the weakness of the currencies against which it is trading.

The US and Europe have both been fighting off recession since the middle of last year and the war with Iraq has increased traders’ uncertainty.  These concerns have driven down the dollar and the pound since the beginning of 2003 and conversely pushed up the value of the rand.

Economic evolution

The peculiarities of South Africa’s economy also play their part.  The Government has been working hard to improve the position of its economy and its population, putting in place measures that are internationally recognised to have a beneficial effect.

"They have given the Central Bank independence; they have set an inflation target of 3% and they are trying to control public spending," says economist Trevor Williams at Lloyds TSB.

Unfortunately, the country is way off its inflation target with the cost of living increasing by 8% a year at present.  Public spending is also too high, despite government efforts. Ministers are spending around 9% more than they are receiving from taxes.

Such a deficit is highly inefficient. It means that the government is forced to borrow money from big institutional investors, and the more the government borrows, the less money institutions have available to lend to companies.

 In addition, ministers have to keep interest rates high to persuade institutions to invest in their debt.  The interest rate for companies is running at 17% right now and this makes it hard for all industries to invest and grow.

 "The growth rate is South Africa’s big problem," says Barclays Capital’s Vogel.  The country’s economy grew by 3% last year and growth has averaged little more over the past three years. This is all very well in a developed country such as the UK but in South Africa it is not good enough.

"The economy really needs to grow more quickly to mop up the growth in the labour force," comments Williams.  Unemployment in South Africa has been estimated at anything between 15% and 30%.

The wide fluctuation is partly due to differing definitions from the South African government and the outside world but also because there is a large informal economy in the country, with many people working without declaring their income to the authorities.

The number of people of working age is also expanding fast, at 4% to 5% a year. Since the economy is only growing at 3% annually, this suggests a rising unemployment problem.  The HIV illness is also taking its toll on the economy. "There are a lot of sick workers and that hits productivity," says Vogel.

Most economists agree that South Africa is trying hard but it has many challenging issues to overcome.  "There are structural problems that need to be addressed. Unemployment is extremely problematic as is education or the lack of it.

These issues could take years to put right," says Investec’s Shaw.  Silver lining to difficulties Perversely, South Africa’s deep-seated economic difficulties are not entirely bad news for wine producers.

They suggest that the recent strength of the rand is soon likely to run out of steam. Lloyds TSB predicts an exchange rate of 13.5 rand to the pound by June and a rate of over 16 by next March.

"We do a lot of business with the supermarkets and the most important factor for us is the strength of the rand," says Richard Cochrane of distributors Bibendum.  The company’s biggest South African imports are Waterside White and Railroad Red and Cochrane says the rand’s recent strength has had a noticeable impact.

 "Twelve months ago, the pound was pretty strong so that was good for them. Now it’s softened so they get fewer rand for each container of wine," says Cochrane.  Western Wines, the top importer of South African wines and the UK distributor of the Kumala brand, echoes Bibendum’s view.

"There are two pressures in South Africa right now. One is a supply problem and the other is the rand," says Western’s Mike Paul.  He also suggests that the country cannot afford to let currency pressures affect its pricing. "Prices must be driven by competition.

You can’t allow currency volatility to affect prices.  The market must come first," he argues. But according to Cochrane, the appreciation of the rand has had some positive effects.

"Promotions are a verysignificant part of the mix and their cost has gone down.   Every pound the wine producers give away is now costing them only 12 rand whereas before it cost them 16," he says.

Barrels and other imported dry goods have also come down in price thanks to the currency’s strength but Cochrane admits, "The most important element is what is being sold in the bottle and in that respect producers are making less money."

Sophie Waggett of the trade group Wines of South Africa (WOSA) is more blunt.  "There is a huge squeeze on margins," she says. The competitive situation is such that winemakers have to be extremely careful before putting up their prices. Off-trade competition is intense, particularly among New World producers.

Nonetheless, Western Wines is considering raising the price of Kumala this summer. "We want to take the price from £3.99 to £4.49," says Paul.

This, apparently, is not a reflection of currency pressures but comes down to lack of supply. There is also a desire to reposition the wine, following substantial improvements in techniques and equipment.

 "We need to move forward in a balanced way. The wine is cheaper on average than other countries’ and we want to get the price up by 30% over three to four years," Paul explains.  In the short-term, retailers are already noticing some price increases.

"When the rand weakens, that’s when we start talking about price reductions. When the rand strengthens, we tend not to pick up the phone," says Matthew Pym, South African buyer at Majestic, only half in jest.

Pym admits though that the quality of the wine has improved to the extent that even if prices have risen slightly, the value of the product has increased. "There are some cracking wines coming out of the region," he enthuses.

Currency competence uncertain Large importers point out that currency fluctuations are a fact of life in the wine trade.  They are something that everyone involved would rather not deal with but they play a part in the business and they cannot be ignored.

Unfortunately, many participants in the wine industry do try and ignore them.  "The difficulty is that wine producers’ core competence is not currency – so it is difficult for them to make budget or put together proper economic models," says Cochrane.

James Oldsborough at Western Wines says the yo-yoing rand is not the only problem that winemakers have to face.  "There is a real lack of investment in the Cape Town port. Capacity is limited and there are draconian rules and regulations. Vessels are constantly delayed and that means customers are dissatisfied," he explains.

Meanwhile, shippers are lobbying for change but the bureaucracy is burdensome.  The government is trying to act in a modern way but is not always entirely successful. The economy is, however, more stable than it was in the early 1990s and wine production reflects this. In the past 10 years, the South African wine industry has grown by 962% and last year it exported more than 200 million litres, over a quarter of which went to the UK.

 During the coming year, the rand is expected to weaken, providing a further impetus to growth.  Sophie Waggett at WOSA believes, however, that the pace of depreciation will not be fast enough to prevent significant change in the industry.

 "There are a lot of players in South Africa and they are not going to be able to rely on the rand to keep them going," she says. "The currency’s recent strength may just accelerate consolidation in the region."