The risk of South Africa and the rand facing an Argentinean crisis

Argentinians did not have much time to enjoy their recent victory over the Springboks in Mendoza, after the country’s beleaguered currency – the peso – slumped to a new record low of 37 to the US dollar.

This is despite the central bank hiking short-term rates to the asphyxiating level of 60%, says Dave Mohr chief investment strategist at Old Mutual.

“The Argentinean government requested that the International Monetary Fund (IMF) accelerates payment of the record $50 billion bail-out. But rather than comfort markets, it had the opposite effect,” he said.

“The market has seemingly lost faith in Argentina’s promise to gradually close the budget deficit (i.e. gradually reduce the amount it has to borrow every year).

“The only way to do so is to aggressively cut spending and raise taxes. This will not only make them deeply unpopular, and risk derailing the government’s other reform efforts, but will also further cripple the economy.

“But the lack of a domestic capital market means that Argentina is at the mercy of global investors and the IMF, and therefore not only cruelly exposed to swings in its exchange rate, but to the vicious cycle of currency weakness further undermining its credit worthiness.”

Sell-off

Mohr noted that other emerging market currencies sold off in sympathy, especially the Turkish lira, but also the rand, which fell to R14.68. This means that the local currency lost 11% during the month of August.

However, he noted that this was in line with the Brazilian real and the Russian rouble, but worse than the Indian rupee’s 4% decline (though the rupee fell to a record low against the greenback).

The lira, in contrast, slumped 37% and the peso by a similar amount.

“While there has been a spill-over from Turkey and Argentina to other emerging markets, it is still not a full-blown contagion,” he said.

“Markets are seemingly still drawing a distinction between countries that are in deep trouble and those that are merely vulnerable.”

South African risks

So what about the risk of South Africa facing an Argentinian-style fiscal crisis?

“Ratings agency S&P Global noted this week that unlike Turkey, which it recently cut deeper into junk status, South Africa’s current rating was unlikely to change, due to moderately faster expected economic growth, a steady outlook for government debt and the expectation that government would gradually implement economic and social reforms,” said Mohr.

He added that budget data for the first four months of the current fiscal year (which started in April) shows a R123 billion deficit.

“The good news is that this cumulative deficit is R5 billion smaller than for the same four months last year,” he said.

“Also encouraging is that revenue growth is outpacing spending growth year-over-year with revenue growth of 11.6% against expenditure growth of 7.3%. This is also broadly in line with budgeted growth in revenue and spending.”

However, there are some substantial deviations from target within the tax revenue category, Mohr warned.

Revenue from the fuel levy is growing faster than budgeted (10% year-on-year), something that few motorists will be happy about, Mohr said, especially given that another more petrol price hikes are expected in the future. Revenue from customs duty is also growing much faster than planned, he said.

“The three biggest tax items are personal income tax, VAT and company tax. All three are slightly lagging growth targets, but in the case of company tax, it is lagging a target that was very low to begin with (6%). This points to the weak business environment.”

Mohr said that the upcoming October mini-Budget provides the Finance Minister with an opportunity to fine-tune revenue and spending estimates.

“Unfortunately, it is likely that he will have to project a larger deficit than the 3.6% estimate from the February Budget.

“A number of unplanned spending items have crept up, including further bail-out requests from State Owned Enterprises, and a wage agreement beyond what was budgeted for.

“But at least there is some progress on fiscal consolidation. Importantly, there is also virtually no risk that the South African government will not be able to fund itself in the bond market. Most borrowing (90%) is locally, and in the local market,” he said.


Read: Moody’s warns South Africa by cutting its 2018 economic growth forecast by half

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