Why Absa is bullish on the rand – and where it sees the currency by year-end

The macro economics team at Absa believes the rand will recover further into year-end, despite a slip in recent sessions.

Absa senior economist Peter Worthington, said in a virtual round-table discussion on Wednesday (5 August), that South Africa has been hit especially hard with a sharp increase in Covid-19 infections in recent months.

However, in the second half of July, these numbers had begun to plateau.

He said that there is still considerable uncertainty about how the pandemic will evolve and, with health care facilities stretched, the human and economic costs of the pandemic will remain a problem for some time to come.

“South Africa still has an astonishingly high number of cases. We aren’t in anyway near through the crisis,” he warned.

Absa noted that global risk aversion continues to wane due to the unprecedented level of global monetary and fiscal stimulus measures. These stimulus measures are supporting global commodity prices and reigniting the demand for emerging market assets in general.

It said that firmer commodity prices should promote trade inflows, while South Africa’s relatively high bond yields should attract capital inflows.

For the rand, Absa said that its peer model implies that the the local unit remains significantly undervalued relative to other high-yielding and commodity-based currencies. And, from a purchasing power parity basis, the rand could strengthen by 8% before the exchange rate would become ‘uncompetitive’.

“Therefore, we still expect the local currency to strengthen to R16.00/USD by quarter-end, before reaching R15.75/USD by the end of the year – which is now the most bullish rand view in the market,” it said.

A fresh wave of heightened Covid-19 fears and/or the inability of the SA authorities to bring about meaningful structural reforms pose the biggest risk to a contractive rand view, Absa said.

“We expect this year’s government foreign loans from multilateral financial institutions to be rand neutral.”

Bianca Botes, executive director at Peregrine Treasury Solutions, said in a note on Wednesday that the rand saw yet another 2% weakening to R17.53/$, as risk-off sentiment is revived, aided by the Beirut explosion.

Providing some hope for the ailing unit, the gold price soared above the $2,000/oz mark, as caution continues to dominate markets. However, Botes said that global sentiment continues to drive the local currency, with little optimism about in the short term.

“The rand is now mustering momentum to break above R17.50,” she said.

  • Dollar/Rand: R17.34  (-0.18%)
  • Pound/Rand: R22.66  (-0.24%)
  • Euro/Rand: R20.47  (-0.14%)

Absa also moved to revise its forecast for GDP contraction this year to 8.3% from 9.7% previously. This revision mostly reflects the better than expected data from Q1 and Q2, it said.

“But given the recent escalation in new cases, we now believe that the economic recovery in H2 20 is likely to be slower than we previously expected amid extended lockdown measures, more localised disruptions to activity from ongoing Covid-19 outbreaks, and a large negative demand shock from job losses and the expiration of some of the government’s economic relief initiatives.

“For 2021, we forecast a partial recovery of 2.4%.”

As the pandemic continues to unfold, South Africa faces an unprecedented level of economic uncertainty and challenge. Despite some promising results in early vaccine testing, it is still too early to tell how long the pandemic as well as its associated health and economic costs will persist, Absa said.

Even if an effective vaccine is found soon, developing the capacity to manufacture and distribute the vaccine across most parts of the world is likely to take some time.

For South Africa, a small developing economy that was already riddled with a host of structural challenges, including high levels of inequality, elevated joblessness, poor potential growth, long running reform inertia and depleted fiscal policy space, the pandemic will cause big economic scarring.

“The recovery is likely to be protracted and uneven, particularly in an environment that is likely to be characterised by much higher levels of leverage in both the private and public sectors.”

Thus, the policy challenges in the post-Covid-19 environment will be larger than ever, the group’s analysts said.

In this regard, the MTBPS in October will be a critical test of the government’s resolve. But more broadly, president Ramaphosa has indicated that the government is preparing the ‘third phase’ of its economic policy response to the crisis, which will be focused on structural reforms and a privately financed infrastructure drive to rebuild confidence and boost medium-term growth prospects.

“While we would like to be optimistic about this, the government’s inability to implement reforms in the past due to ideological conflicts within the polity, capacity constraints and coordination problems does not make for an especially inspiring outlook on reforms.

“That said, as we have argued above, there is potential for upside as well as downside developments relative to our fairly conservative baseline forecast. No doubt the next handful of months will produce a number of important developments that might point a clearer way forward,” Absa said.

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Why Absa is bullish on the rand – and where it sees the currency by year-end