The rand has been surprisingly strong since early April with a few reversals along the way, says Bianca Botes, executive director at Peregrine Treasury Solutions.
In a research note, Botes said that the rand’s lowest point this year came unexpectedly just over a week into South Africa’s extreme lockdown.
The local unit weakened to R19.08/dollar on 6 April 2020. After its rapid decline to that level, it spent the next six months in a ‘generally strengthening’ trend, although experiencing set-backs along the way.
By 18 September, the rand had clawed back over 15% of its value to reach R16.13/dollar, Botes said.
“But this was still some way off the R13.99/dollar level at which the rand kicked off the year. And while the timing of the rand’s recovery mirrors the country’s lockdown, it’s important to realise that the two are not connected.
“In fact, if local factors were being taken into consideration, the rand might have moved in the opposite direction,” Botes said.
In March, South Africa implemented one of the strictest lockdowns worldwide in an effort to flatten the coronavirus curve in a society where many face existing health conditions such as HIV, TB and diabetes.
“The extreme restrictions – which initially limited the manufacture and sale of anything beyond the barest of essential items – had a hugely deleterious impact on an economy which was already in a recession going into the lockdown,” said Botes.
“As a result, the South African economy suffered untold damage with estimates for 2020 growth now ranging from a contraction of 8% all the way to 12%, while the global lockdown measures and risk factors weigh heavily on the local currency.”
Botes said that it is clear that this is an economy in dire need of stimulation, a mechanism which aims to grow the demand for goods and services and through creating additional jobs, higher incomes and additional tax revenue for government.
There are typically two levers to stimulate a faltering economy: fiscal stimulus and monetary stimulus, she said.
“Traditionally, fiscal stimulus is an increase in government spending combined with a reduction in taxation, while monetary stimulus is deployed by the central bank, consisting of interest rate cuts and the purchasing of government bonds, also known as quantitative easing (QE).
“In effect, these measures leave more money in the hands of businesses and individuals, which increases their ability to spend money on goods and services, thereby boosting the economy.”
Most of us are familiar with the effect stimulus can have on other aspects of the economy, such as an increase in inflation and the devaluation of currency that are often a direct result of interest rate cuts.
“In South Africa, the South African Reserve Bank (SARB) has argued that QE has not been used for stimulus – and the term itself has only found its way into our lexicon recently – stating that it is purchasing bonds in the secondary market to provide liquidity and is not QE. The essence of it is in fact the same: purchasing government bonds, albeit not directly from the government.”
On the other hand, Botes said that stimulus packages are often perceived as hard cash – which is not the case.
Instead, she explained the government’s R500 billion ‘stimulus’ package as follows:
- The reallocation of R130 billion of existing funds from other capital expenditure that was already budgeted for;
- The deferment, not cancellation, of tax – the same amount will be paid by business, just at a later stage;
- A loan guarantee scheme of R200 billion – basically government is underwriting debt, in partnership with the major banks.
Botes said that two questions arise on the back of the aggressive stimulus deployed:
- Is it sufficient to save the South African economy?
- “The short answer is, in all likelihood, no. The local economy was in a recession prior to the pandemic, and the subsequent lockdown will see economic turmoil for years to come. With the mass closure of businesses, we saw a rapid increase in unemployment. This will, in turn, lead to additional fiscal pressure.”
- Where to from here?
- “One cannot rely purely on stimulus to save the economy. While it remains a valuable tool for cyclical downturns, it cannot correct or counter structural shortcomings. Government policies will require drastic reform towards a pro-growth economic policy that will aim to attract foreign direct investment (FDI), and support the business environment.”
Where does this leave the rand?
Stimulus, in the absence of demand shocks such as those brought on by the lockdown, will lead to inflation, and the devaluation of currency, said Botes,
“In the absence of demand, stimulus will fail to generate an uptick in inflation, however, the lockdown is not infinite.
“Should too drastic measures be taken now – such as allowing the SARB to purchase government bonds directly from the treasury as a means of funding – the effects could be catastrophic in terms of severe devaluation of currency and hyperinflation as seen in Zimbabwe,” she said.
So what is driving the rand?
While the underlying factors determining the rand’s value would suggest it should be weak, its movements have been largely driven by global factors and risk appetite, said Botes.
She said that the local stimulus package pales into insignificance in comparison with that in the US and the rand strength has rather been a reflection dollar weakness.
“It is no coincidence that the dollar peaked in the first week of April and declined through to September.
“However, given the dire South African economic data as a result of the lockdown – local GDP slumped 51% in the second quarter (seasonally adjusted, annualised) – there are numerous local risks to the currency looming.”
In addition, Botes said that the currency market must account for the following hazards:
- Risk aversion as a result of the global fallout of Covid-19;
- Downgrades by all three ratings agencies to sub-investment grade, and South Africa’s subsequent exclusion from the WGBI;
- A poor South African outlook amidst the pandemic, and the expected effect it will have in the future.
“All-in-all, while the rand will find bursts of strength from any dollar weakness, the local unit’s underlying trend points to a weakening currency in the long term. We would suggest making use of any rand rally to fill up on foreign currency requirements,” Botes said.
George Herman, chief investment officer at Citadel, said that the rand started the year at R14.00/$, with the group’s year-end target at that time, at R16.50.
In the near term, US election debates will continue to take up the focus of investors, as they will have implications for the November ballot, he said in a note.
“With short-term dollar weakness still on the horizon, the original R16.50/$ 2020 year-end forecast seems reasonable,” said Herman.
He said that 2021 promises to be a global recovery year, so a benign growth and commodity environment should support the rand in general.
Phases of global risk-on sentiment will support the rand and a test of sub-16.00 is highly likely.
“If, however, the rand is considered fair value around R16.50 by the end of 2020, it makes it difficult to see a meaningful and sustained rally beyond R15.50 during the year.”
He said that the probability of sub-R16.00 by end of 2021 is 10%.
Interest rate parity is like gravity in forex markets, so the rand faces at least 75c of weakening due to this factor alone, placing the equivalent fair value for end 2021 around R17.25, said Herman.
He said that the probability of the rand between R16.50 and R18.00 at the end of 2021 is 50%.
“The poor credit metrics are bound to materialise eventually,” he continued. 2021 might still be early, but the first IMF loan repayment is approaching fast.
“With SA’s weak growth dynamics, a comfortable growth-led resolution to the debt metrics is highly unlikely, if not near impossible,” he said.
Herman said that the probability of the rand weaker than R18.00 by end of 2021 is at 40%.
At 12h35 on Monday (5 October) the rand was trading at the following levels again the major currencies:
- Dollar/Rand: R16.40 (-0.77%)
- Pound/Rand: R21.20 (-0.80%)
- Euro/Rand: R19.27 (-0.57%)