FX analysts are used to fluctuations in South Africa’s currency. It tends to suffer disproportionately when emerging market (EM) risk sentiment is low, but rise faster than others when there is optimism in the air.
Having been hammered by the coronavirus outbreak, the rand is now at pre-pandemic levels. And Nedbank chief economist Nicky Weimar says it is rapidly approaching fair value, based on purchasing power parity.
“If one considers that South Africa’s economy is far more inefficient than those of its major trading partners, the rand’s undervaluation is probably close to 3%,” she says.
“The currency tends to overshoot on the way up and the way down, and the current firmer trend will continue for as long as global sentiment holds.”
Elna Moolman, head of macroeconomic, fixed income and currency research at Standard Bank South Africa, notes that the country’s terms of trade reached record highs this year.
Few believe [the government] will be successful
Nicky Weimar, Nedbank
“We estimate that the growth in export destinations, weighed according to their importance for exports, will be the highest in a decade next year,” she adds.
“We expect a sizeable current-account surplus for 3Q20 and the current account should be well supported into 2021, which provides strong support for the rand.”
The weaker dollar has had a notable impact on USD/ZAR, with rand appreciation after the result of the US presidential election, while the South African currency also derives support from its status as a carry currency, owing to its high interest-rate differentials relative to advanced economies.
At a time when many countries are in negative rate territory, the benchmark rate in South Africa remains at 3.5%.
Jeffrey Schultz, chief economist at BNP Paribas South Africa, highlights a number of supportive factors for high beta, liquid EM currencies such as the rand.
There is ample USD liquidity, policymakers are likely to keep their foot on the accommodation pedal to safeguard economic recoveries, and reflation should come with gradually improving activity and demand.
There is scope for the currency to perform well into the end of the year
Jeffrey Schultz, BNP Paribas South Africa
“As an idiosyncratic story, we also think there is scope for the currency to perform well into the end of the year as more encouraging real economy data emerges around Q3 GDP growth and the current account surplus,” he adds.
Disappointing
However, analysts are not exactly lining up to congratulate the South African government for its efforts to revitalize its economy, despite acknowledging that Cyril Ramaphosa faced a big task when he took power in 2018.
“Hopes for a major reform effort have been repeatedly disappointing,” says Elisabeth Andreae, EM economist at Commerzbank. “One of the main reasons for hesitant progress is the ongoing power struggles in the ruling African National Congress and in the cabinet.”
Nedbank’s Weimar suggests the administration also lacks the skills to deliver infrastructure on time and on budget.
“Fiscal consolidation is probably the biggest contribution government can make to the country’s growth prospects over the medium term,” she says. “And while it has officially committed to reducing the budget deficit to contain the rise in the public debt burden, the plan rests almost entirely on cutting the public sector wage bill.
“Few believe it will be successful in this endeavour.”
The administration’s economic reconstruction and recovery plan (ERRP) is designed to kick-start a sustainable economic recovery.
Unfortunately, the legacy issues created by state capture – whereby businesses and politicians conspired to influence decision-making processes to advance their own interests – has reduced institutional capacity and effectiveness, emphasising the urgent need for a tighter system of checks and balances to stamp out corruption.
“The president has appointed oversight bodies through the National Economic Recovery Council,” explains Tertia Jacobs, a treasury economist within Investec’s corporate and institutional bank.
It is important that ministers be held accountable
Tertia Jacobs, Investec
“This is an improvement from the complete lack of coordination and cohesion between the various cabinet portfolios under the Zuma administration. However, it is equally important that ministers be held accountable.”
Last week, Moody’s and Fitch downgraded South Africa’s long-term foreign currency ratings by one notch, to Ba2 and BB-, respectively, while S&P left its BB- rating unchanged with a stable outlook.
The downgrades might have been expected to push the rand down, but previous experience suggests the impact of such moves is temporary.
The data and information required for credit-rating decisions have already been partially priced in by the market, says Commerzbank’s Andreae.
“However, the emergence of negative factors such as disappointing vaccine results or renewed global trade disputes would place a heavy burden on the rand,” she adds.
Moolman at Standard Bank agrees that the latest rating cuts have had limited impact, but warns that there are exceptions when ratings cross certain thresholds – such as for inclusion in the World Government Bond Index (WGBI), which the country exited in April when it lost its last investment-grade rating.
“A slip into single-B rating territory might be another important threshold that could disproportionately weigh on investors’ ability to invest in South Africa, which could in turn have a rating-specific impact on the rand beyond the usual fundamentals,” says Moolman.
The rand’s reaction to the credit rating agencies’ downgrades has been muted in the context of global risk-on sentiment, driven by a decline in US political risk and successful vaccine trials, concludes Investec’s Jacobs.
“Event risk for the rest of 2020 is mostly clear, so the primary drivers of the currency are likely to be external,” she says.
