These are the 5 big risks that may derail the rand

It’s looking like the latest emerging-market turnaround story: a rebound of about 20% from a one-year low for South Africa’s rand. The question is whether it will stay that way, writes Bloomberg.

The news group pointed out that the currency traded stronger than R12 per dollar on Wednesday for the first time since May 2015, extending a rally sparked by Cyril Ramaphosa’s election as leader of the ruling African National Congress, and supported by global risk-on sentiment and the greenback’s retreat.

“Three months ago we were staring down the barrel of total junk status,” said Warrick Butler, the head of emerging-market spot trading at Standard Bank Group Ltd. “Today the mood has rotated 180 degrees.”

Zaakirah Ismail, fixed income strategist at Standard Bank, said that the rand’s push on Wednesday was due partly to dollar weakness. “But the new ANC president being Cyril Ramaphosa has sparked optimism that SA could avoid a Moody’s credit rating downgrade. Positives include: policy reform, alleviating economic growth constraints, and addressing the fiscal risks stemming from SA’s SOEs.”

Ismail said that comments that the ANC has a plan for president Zuma’s exit added to positive sentiment this week. “Speaking in Davos yesterday, deputy president Ramaphosa said that the dialogue with President Zuma was progressing, and that he wanted to ensure that the transition in leadership would be managed delicately.

“We await DP Ramaphosa’s media briefing today in Davos for further positive signs on policy and political improvement.”

The currency specialist said that SA assets will find support from any positive policy moves by the ANC. “We maintain our USD/ZAR at 12.00-12.20 trading range; however, any further credible political improvements may result in some overshoot of our estimate.”

Shortly after 10h00, the rand remained on the front foot against the major currencies.

  • Dollar/Rand: R11.89 (0.23%)
  • Pound/Rand: R16.98 (0.34%)
  • Euro/Rand: R14.80 (-1.65%)

Bloomberg outlined the key drivers of the recent rally, and the risks that may derail it:

Political Outlook

The election of Ramaphosa as leader of the ruling ANC in December, setting him on a path to take over as head of state from the scandal-ridden President Jacob Zuma, has fueled optimism South Africa may avert further credit-rating downgrades as the new leadership takes steps to root out corruption and stimulate the ailing economy.

Moody’s Investors Service is now less likely to lower the nation’s credit rating when it reviews its assessment in March, according to UBS Group AG. This month, the cost of insuring South Africa’s dollar debt against default for five years has dropped to the lowest level since 2013, when the nation still had investment-grade ratings from three major companies.

S&P Global Ratings and Fitch Ratings Ltd. cut the country’s debt to junk in 2017 after the removal of Pravin Gordhan as finance minister in March. Moody’s put the nation on review for a downgrade in November. A reduction of the local-currency bond rating to junk would trigger an exclusion of South Africa’s rand debt from Citigroup Inc.’s World Government Bond Index, sparking a selloff by investors tracking the gauge.

“Lackluster growth, high unemployment and a deteriorating fiscal balance sheet require urgent reforms,” UBS strategists including Jonas David, who see the rand holding around 12 per dollar over the next year, wrote in a Jan. 22 note.

“The leadership has a window of opportunity to implement changes ahead of the 2019 general elections. Recent developments lower the probability of another downgrade.”

Commodity Prices

The commodity-price boom of the past seven months is providing support for the rand. South Africa depends on raw materials — including precious metals such as gold and platinum, as well as industrial metals – for more than 50% of its export earnings. That’s helped narrow the current-account deficit to 2.3% of gross domestic product, from as wide as 6.9% four years ago, easing pressure on the currency.

The shrinking external deficit “should limit the rand’s downside in times of less favorable global conditions,” according to the UBS note.

Investor Sentiment

Investors are becoming more bullish on South Africa. After dumping almost R47 billion ($3.9 billion) of South African stocks in 2017, foreigners are buying Johannesburg-listed stocks at the fastest pace on record in 2018. That’s helped propel the benchmark index to an all-time high, led by shares of companies that depend on the local economy, such as banks and retailers.

“South Africa itself will be a big story this year,” said John Ashbourne, an economist at Capital Economics. “We think that the economic cycle as turned, and that growth will accelerate again this year. After years of downbeat forecasts, I think that a lot of analysts will be taken surprise by some good news out of South Africa.”

Dollar’s Demise

Continuing dollar weakness has supported most emerging-market currencies including the rand, and that’s set to continue in coming months, according to Swedbank AB. A gauge of developing-nation currencies is trading at its strongest level against the dollar in four years.

“Emerging markets are strong on the basis of a weak dollar and strong commodity prices,” said Hans Gustafson, the chief emerging-market strategist at Swedbank. “Our forecasts have been adjusted upwards for all emerging-market currencies as the dollar has depreciated faster than earlier thought.”

Lurking Risk

Even if Ramaphosa replaces Zuma as president, he may not be able to force through unpopular fiscal reforms, according to Informa Global Markets. The budget presentation on Feb. 28 will tell whether the government has the will to curb rising debt and a widening budget deficit.

“We are reluctant to turn too optimistic on the rand just yet, given somewhat murky medium-term prospects,” said Natalie Rivett, a senior emerging-market analyst at Informa. “We would expect to see some faltering of the rand as we head closer to the February budget, which will be the next key risk event and could be the deciding factor as to whether Moody’s will deal a blow to the sovereign’s local credit rating.”

Reuters meanwhile, quoted finance minister Malusi Gigaba as saying that the upcoming budget would require interventions in order to spur on the economy.

“What I will be doing at the budget will be going to announce the tough decisions to stabilise the debt but reduce the budget deficit,” he said, speaking on the sidelines of the World Economic Forum in Davos.

“We have to announce tough decisions and South Africans will have to bear some pain (as a result) of some of the decisions we are going to have to announce in order to stabilise our debt,” he said.

Reporting with Bloomberg.

Read: This is the ‘real’ value of the rand against the dollar

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These are the 5 big risks that may derail the rand