Finance

How the rand can get back to R14 to the dollar

Luke Fraser

 ·23 Aug 2023

Investec’s economic scenario modelling shows exactly what conditions would have to be met for the rand to return to the R14/$ mark by the end of next year – but South Africans should not hold out hope for this happening.

Despite being one of the worst-performing major currencies in the world, the rand made a strong recovery in July – recovering from close to $20.00/$ to R17.55/$.

The decline in risk aversion, the drop in the severity of load shedding and local investors reducing their offshore exposure to remain within prudential limits led to a strong recovery.

However, the rand again saw a massive drop only a few weeks later – breaching the R19.00/$ mark yet again.

Investec Chief Economist Annabel Bishop said that the summer holiday period in the Northern Hemisphere increased risk aversion, which hurts emerging economies like South Africa.

“While the US dollar has been generally softer since the start of this year, with investors anticipating the end of the US rate hiking cycle as inflation eases, some uncertainties surrounding the peak in US policy rates and growing hopes of a soft-landing in the US economy appear to be supporting the greenback in recent weeks,” economists at Nedbank added.

The rand has faced a period of extreme weakness for several years, and according to the Economist’s latest Big Mac Index, it is one of the most undervalued currencies in the world, with an implied exchange rate of R8.94/$.

Adjusted for GDP, the rand should be trading closer to R11.00 to the dollar, the Index showed – but most economists pin the “fair value” of the rand at about R14.00 to the dollar, given its various core issues.

The last time the rand was even close to R14.00 to the dollar was almost two years ago exactly when it traded at R14.12 to the dollar in September 2021.

Given the extreme volatility of the rand, economists have remained divided on where the rand will exactly go in the coming months and years, with both upside and downside risks present.

Investec looked at all the possible directions that the rand could go and how likely these are:

R14.40/$ – Extreme Up Case – 1% Chance

For the Extreme Up Case, which would send the rand closer to its fair value, South Africa’s economic growth rate would have to rise to 3-5% and then 5-7% per annum.

The country would also need good governance, growth-creating reforms, strong property rights, no nationalisation or expropriation without compensation, high business confidence, fixed investment growth, while fiscal consolidation drives debt to the low ratios of the 2000s.

Domestic inflation would also have to drop due to extreme rand strength and the country would have to experience extremely favourable weather conditions.

There would also have to be strong global growth, a commodity boom, an upgrade of credit ratings to investment grade, a short greylisting and a quick transition to renewable energy.

When factoring in all these requirements, it becomes clear that this is extremely unlikely.

Hence, the rand only has a 1% chance of reaching R14.40/$ by Q4 2024, Investec’s modelling shows.

R16.60/$ – Up Case – 1% Chance

There is also only a 1% chance that the rand will drop below R17.00/$ by Q4 2024, the finance group said.

In the Up Case, economic growth would need to lift towards 5.0%, leading to increased business confidence and investment.

There would also have to be no nationalisation of expropriation without compensation. Good weather and global conditions would also be needed to keep domestic inflation low.

Credit ratings would also have to be upgraded due to fiscal consolidation and lower borrowing. South Africa would also need to be greylisted for less than 18 months.

There would also need to be a substantial transition to renewable energy while comprehensive measures would be required to alleviate climate change.

R17.25/$ – Base – 47% Chance

The base case scenario is the most probable result for South Africa, where the rand will drop slightly to R17.25 by Q4 2024.

Economic growth will rise to 3.0% on reforms, with global financial risk sentiment being neutral to positive, whilst South Africa retains its BB credit rating.

The rand will stabilise slightly and strengthen somewhat, while inflation is impacted by weather patterns which will affect food prices.

The transition away from fossil fuel usage is slow, but the War in Ukraine eases.

There is little to no expropriation without compensation, and the greylisting is temporary.

R19.60/$ – Lite Downside – 43% Chance

Although the Lite Case has the same international environment as the Base Case, the domestic environment differs.

Business confidence is down due to load and water shedding, there is a weak rail capacity, there is civil and political unrest, a swing towards left-leaning policies and a recession.

Although there is a temporary increase in state borrowing, resulting in the risk of credit rating downgrades furthering, there should be eventual fiscal consolidation.

There is also slight expropriation of private property, which moderately impacts on the economy; a slow move to implement renewable energy and mitigate the effects of load shedding; and high inflation due to the unfavourable weather conditions and a lengthy greylisting.

This would lead to a period of sustained rand weakness, with the rand jumping over R20.00/$ and reaching R19.60/$ in Q4 2024.

R22.80/$ – Severe – 8% Chance

A severe case would spell a period of sustained weakness for the rand, with the scenario seeing the rand jumping above R20.00 as early as this quarter (Q3).

This would need a lengthy global recession, resulting in a global financial crisis.

The ANC/EFF would also have to enter into a colation in 2024, with severe service shortages resulting in widespread civil unrest.

The government would also start borrowing from an increasing number of sources, and South Africa would be rated a single B by all major agencies – eventually dropping to CCC grade. The country will also increase its risk of default and sink deeper into a debt trap.

The country would also fail to transition to renewable energy and fail to mitigate the effects of climate change.

There would also be the full implementation of expropriation without compensation, with a noticeably negative impact on the economy.

High inflation also occurs in this scenario due to changing weather conditions, and the rand suffers extreme weakness.

According to Investec, it is eight times more likely that the rand will jump to R22.80 instead of R14.40 by Q4 2024 – although both outcomes are based on extremely low probabilities.

Read: Things are looking up for interest rates in South Africa