Foreigners have favoured local currency emerging market (EM) debt given the lower yields in developed economies (see figure 3), particularly the Euro area, with the Institute of International Finance (IIF) recording flows of US$35bn into EM assets since mid-March. South Africa’s change in Finance Minister, and  drop in its sovereign credit ratings (see figures 1 and 4), then saw the rand weaken to R13.96/USD, R14.87/EUR and R17.34/GBP. The outlook from S&P is negative, signalling the likelihood of further downgrades (but stable from Fitch), with South Africa’s rand denominated sovereign debt issuance around 90% and hard currency 10%. The rand’s post-downgrade strength reflected the continuation of the global risk-on appetite, particularly to EM local currency debt, with SA still attractive in this respect as the country retains two investment grade ratings on its local currency denominated long-term sovereign debt. With Purchasing Power Parity (PPP) at R10.40/USD currently (see figure 5), the rand’s future attainment of its fair value (or PPP, which is expected to depreciate by about 3-4% per year) by 2020, will depend on SA retaining its investment grade local currency long-term sovereign credit ratings from Moody’s and Standard and Poor’s. A more gradual trajectory than previously is likely in the return to PPP (see figure 5), given the recent downward trend in credit ratings (see figures 1 and 4). The rand could therefore reach PPP in 2020, where PPP valuation will then be closer to R11.50/USD. Loss of another investment grade local currency long-term sovereign credit rating would delay the return to PPP further, while loss of all investment grade local currency long-term sovereign credit ratings would mean the rand would be unlikely to return to PPP (see figure 20).

The domestic economy is likely to see its growth constrained below 1.0% this year (at 0.8% y/y), insufficient to stimulate needed increases in tax revenues without tax increases. This weak economic growth rate for SA this year is likely, despite the improvement in global growth, as a result of the negative effect on business sentiment following the switch in Finance Ministers, and the credit rating downgrades.