21 Aug 2018

Rand note: currency moves continue to be led by the domestic politics of the day, and global events

Annabel Bishop

Chief Economist

Currency moves continue to be led by the domestic politics of the day, and global events

  • With a reported upcoming announcement around midday today on the possibility of President Zuma’s resignation, as the ANC is said to have been discussing his recall for the past few weeks, the rand has ticked stronger, to R11.90/USD, R14.64/EUR and R16.49/GBP, while the R186 has been flat at 8.39%  
  • Since Cyril Ramaphosa became President of the ANC, R30.2bn has flowed into South Africa from foreign investors, on a net of sales basis for portfolio investment, assisting in the rand strengthening by close to R2/USD. This is in comparison to the prior around R200bn net outflow of foreign holdings of SA equities (since end 2015) when risks for the economy had been perceived to be very heavily tilted to the downside (of a decline through the sub investment grade credit rating tiers, thereby raising the risk of ultimate debt default).
  • The rand’s fair (purchasing power parity) values respectively are calculated at R10.00/USD, R12.50/EUR and R13.50/GBP, which would likely be the levels the rand could track towards eventually on a Cyril Ramaphosa Presidency of SA that proved to be growth and credit positive under free market reforms.
  • Substantial further rand strength would cause meaningful additional fuel price cuts, and place downwards pressure on CPI inflation and interest rates, bolstering consumers purchasing power. Sustained rand strength below R11.50/USD and against the crosses would likely see the SARB remove its two interest rate hikes it is factoring in for SA, and instead realistically consider interest rate cuts.
  • Indeed, an early Zuma exit (this week) could see the rand strengthen to R11.70/USD, and then move towards R11.00/USD providing that Cyril Ramaphosa can assume Presidency of SA without any conditions that hamper his ability to follow the free market reforms necessary to avoid further credit rating downgrades, eradicate corruption and deliver rapid economic growth.
  • The perceived frequent, conflicting political and economic policy proposals, especially populist ones of the past several years, are seen to have negatively impacted sentiment levels, in turn severely suppressing investment and economic growth, and so causing unemployment rates to escalate. 
  • Specifically, business confidence has been depressed for a lengthy period (since 2009 it has averaged 41%, well below the neutral 50 level) as per the BER, and in the last quarter of 2017 it recorded 34, meaning that 66% of businesses were dissatisfied with prevailing conditions at the time. 
  • South Africa has lost multiple investment grade credit ratings and so the cost of credit has risen – substantial deterioration in the fiscal health of government’s finances has occurred, with a sharp rise in borrowings and expenditure. Credit rating downgrades and the resultant higher cost of borrowing has caused a risk overhang that has meant that SA has been unable to enjoy markedly lower interest rates in periods when the rand strengthens substantially (on global to global events). 
  • The credit rating agencies worry about SA’s anaemic economic growth rate, and concomitant poor GDP per capita performance, just as much as they worry about the hefty rise in borrowings and so insufficient fiscal consolidation. Despite some political change and perceived improved governance at Eskom led by Cyril Ramaphosa, little further tangible progress has occurred to avoid full junk status for SA this year after the MTBPS’s fiscal slippage. 
  • Indeed, political uncertainty has risen recently in SA on opposition parties pushing for a no confidence motion in President Zuma, the ANC reportedly continues to discuss recall and two perceived centres of power in the country exist (President of the leading political party vs President of the Country).
  • South Africa could see a better than expected economic growth outcome this year and next, compared to the consensus forecasts published at the start of January (but likely made before the ANC elective conference), should Cyril Ramaphosa become President of SA early this year on an anticipated upsell in business confidence. 
  • Furthermore, the consequent, expected substantial upswing in investor sentiment could see both higher FDI into South Africa, and markedly higher domestic fixed investment growth rates, which could spur economic growth above 2.0% y/y, towards 3.0% y/y, on a more sustainable basis than the drought-recovery-led growth of 2017.
  • South Africa can eventually regain it’s A grade credit ratings, see unemployment drop below 22% and have sustained economic growth above 5.0% y/y again, and repair both its public and SOE finances as it has the capacity to do so, but must now reduce the size of the state substantially, and allow conditions that see the private corporate sector triple in size.
  • Higher commodity prices have given the mining sector some lift, but substantial direct investment (both foreign and domestic) would bring both this sector and the manufacturing industry back to life after almost a decade of weak outcomes on high political and policy uncertainty levels. 
  • While South Africa’s outlook looks brighter than it did several weeks ago, many hurdles still need to be overcome including funding and governance of SOEs other than Eskom, the extreme expenditure pressure on public finances which has resulted in over borrowing and credit rating downgrades (with SA now facing full sub-investment grade status), the lack of substantial free market, structural reforms and many poor performing government departments. 
  • Globally, markets have pulled back from the volatility spike recently as stock markets corrected, with the VIX (stock market implied volatility indexed measure) subsiding to below 30 from spiking close to 50 this week, with some subsidence in risk-off. Prior to this the VIX has seen a low volatility period stretching over 2017 and most of 2018 (averaging 11).