The U.S. president has instead turned his attention to U.S. engagements in the Middle East. He has made a U-turn on his stated intention to pull out of Afghanistan (I could make a joke about his father here…).
So let’s return our attention to local drivers for the currency in the medium to longer term:
- It is now becoming apparent that South Africa will struggle to avoid further downgrades as we head towards the end of the year
- This as government finances come under scrutiny as we move toward October’s medium term budget framework
- Low growth and dismal financial management at state run entities will keep government finances pressured; the problem is exacerbated by poor revenue generation from the increasingly burdened tax base
- Rating agencies are sure to latch onto this – and the probability of further downgrades is increasing.
The question is whether this is adequately priced into South African assets.
On the one hand the low growth environment has led to an improved trade account as imports have decreased. This dynamic is supportive for the rand. Arguably the bigger issue is how much bond selling will materialise if/when these downgrades materialise.
The rand is arguably undervalued by about 10-15% (on a PPP basis). And thus, for now, it appears as if the market is ignoring the risks associated with potential further downgrades.
The hunt for yield is still evident and EM currencies are performing relatively well. This may continue for a while. However, I suspect that as we move towards the end of the year, South Africa Inc’s risks will again highlight the fragility of domestic assets.
I realise I am sounding like a typical analyst here, hedging all sides of the bet (up, if not down, otherwise steady – not necessarily in that order), but I still see amber lights flashing all over the show for the longer term trajectory of the rand. Yes the trade account is improving; yes some of the political noise has dissipated; yes North Korea and the U.S. have backed away from insanely trying to provoke one another.
But few of our domestic indicators are improving (except for inflation). In fact they keep deteriorating and at some point we will have to pay the price.