The fact that the rand is trading below R15/dollar clearly reflects international factors such as the US election outcome, vaccine developments and an abundance of liquidity.
This is the view of Maarten Ackerman, chief economist and advisory partner at Citadel, who warns that the some of the positivity around the local currency could be reversed when the spotlight is once again on the local fiscus.
The first ‘bump in the road’ will be the February Budget Speech, which is likely to remind investors of the country’s poor local economic fundamentals, he said.
“Eventually, as investors wake to South Africa’s economic reality, the rand will come under some pressure again. So, while the rand is currently enjoying the benefit of global tailwinds, it is likely to weaken during the course of the year.
“However, the extent of this weakening will ultimately depend on the government’s progress on fiscal reforms, without which we could see the local currency head north of R18/dollar.
At 11h35 on Monday (4 January) the rand was trading at the following levels again the major currencies:
- Dollar/Rand: R14.52 (-1.15%)
- Pound/Rand: R19.86 (-0.91%)
- Euro/Rand: R17.85 (-0.31%)
Facing fiscal demons
Ackerman said that South Africa has been basking in the glow of risk-on sentiment, the benefits of which are most evident in the local bond and currency markets.
“But, much like holidaymakers who allow festive cheer to tempt them into spending freely on credit, South Africa’s bill will eventually come due, forcing government to return to reality and face its fiscal demons,” he said.
“So far, foreign investor support from the local bond market together with the IMF’s loan have kept the country from feeling the worst effects of the pandemic’s devastation.
“But the holiday will eventually end, and government will need to tighten its belt significantly at the end of the three-year fiscal framework, or towards the end of 2022 and moving into 2023 – especially as its first IMF loan repayment will come due. ”
Even before Covid-19 hit, South Africa had travelled a long way down the road towards a fiscal cliff on the back of an unsustainable and unhealthy government budget. The pandemic simply accelerated the journey to the precipice, Ackerman said.
If the country is to avoid a sovereign debt crisis or the risk of defaulting on our loans, government will urgently need to implement long-awaited structural economic reforms, and markets will be watching for evidence of action rather than simply more talk over the next 12 months, he said.
South Africa lagging economically as it speeds to the cliff
In terms of the local market, it’s important to recognize that South Africa is currently lagging behind its peer group economically, and once the risk-on rally has faded and markets look past global drivers, our looming fiscal cliff and debt issues are likely to be reflected in our asset classes, Ackerman said.
“The majority of earnings produced by JSE-listed companies are generated outside of South Africa.
“However, headwinds in the global environment could filter through to the local exchange as well, while a deteriorating fiscal situation and structural economic issues could hamper the prospects of those companies which operate only in South Africa. Investors thus need to look for exposure to those companies that offer some immunity against the local environment.”
He said that investors should also bear in mind that where the JSE in the past has acted as a useful proxy for emerging markets, as more and more emerging markets become Asia-Pacific focused, they should consider adding other emerging market exposure to achieve true diversification.
“It is also worth noting that, while the local bond market is one of the few in the world that may generate positive returns for investors in 2021, this should be treated with caution and investors should rather consider taking profits or even go underweight.
Bond yields were trading around 9% in March 2020 and, following the Moody’s downgrade to sub-investment grade, these yields exploded to 13% to compensate investors for the higher risk of government default.
“Since then, however, yields have returned to 9%, seemingly indifferent to the fact that our fiscal situation has significantly deteriorated due to the pandemic, and that our budget deficit will be twice the size anticipated at the start of 2020.
“In light of this, it is highly unlikely that the local bond market will continue to trade at current levels indefinitely,” he said.