It has never been easy to predict where the rand is headed but now it feels an even riskier forecast to make. Last week the SA currency managed to break below R14 to the dollar briefly in the wake of the G20 meetings in Japan but soon found its way back up to a level it has tended to return to over the last year or so – around R14.20 to the dollar.
The currency has been caught between international and local changes in confidence and market sentiment, shifting in response to the developments that are tending to hold sway at the time. Last week it experienced the tailwinds of favourable global events, whereas in June it felt the pain of surprisingly poor local growth data, breaking above R15 to the dollar.
Other emerging market currencies have had a better time of it, rallying in response to central banks pivoting from a hawkish monetary policy stance at the start of the year to a more accommodative stance during the second quarter.
While the MSCI Emerging Markets currency index has gained about 4% year to date, the rand is only about 1% ahead of the level it traded at early this year. Andre Roux, Investec Asset Management Co-Head of Fixed Income and Currency and portfolio manager, puts the rand’s performance relative to other emerging market currencies into a perspective: “On a pure beta (market-related) basis, you would expect the rand to outperform other emerging market currencies because it tends to be a high beta currency during periods when currencies are rallying.”
More recently, it has begun to catch up with other emerging market currencies. The rand’s fortunes have improved marginally on the back of what can only be described as a tentative and fragile improvement in confidence in President Cyril Ramaphosa and his slimmer Cabinet’s ability to deliver on key structural impediments to growth. The journey will start with government’s plans to bring Eskom back from the brink of bankruptcy – at great cost to the fiscus.
But South Africa is nowhere close to turning around decades of economic mismanagement and costly corruption. For that reason, Roux, a former member of the Treasury Department, is worried about the outlook for the domestic economy because he views the fiscal situation as so severe. He says there are two issues: the absolute lack of growth, which he finds difficult to explain, and the parlous state of government finances. “Even without the SOE problems,” he says, “it would be a tough challenge for the Finance Minister to halt the rising debt level, which is getting to extremely uncomfortable levels.”
Government needs growth if it is to dig South Africa out of the huge fiscal hole government it has dug for itself. “Without growth, we are not going to see the revenue flows government needs to finance what it wants to spend outside the SOE rescue programmes.” He also believes the SOE bailouts will be bigger than the government estimated during the February Budgeting process, something that is already becoming clear with the Eskom Special Appropriation Bill that government has put forward for approval.
Based on his, and various other measures of the rand’s purchasing power parity, Roux says the local currency looks undervalued. But given the sizeable current account deficit that has persisted for years, he says it could be argued that the currency is overvalued. So ultimately, we are back where we started, with no clear sense of what the fundamental value of rand should be and where it is likely to go.
What we do know is that South Africa, and much of the world, are currently on a knife’s edge: on the one side is a manageable scenario, one in which the global economy slows down and we experience a soft landing, while on the other is a hard landing of catastrophic proportions, one which policy makers could do very little to avoid.
The best-case scenario for the rand, and thus the South African economy, is a world environment in which central banks make some rate cuts and the world economy successfully meanders along a middle path for a while. This muddling through would reduce the attractiveness of the developed world interest rate-linked assets and, in so doing, support flows into higher yielding emerging market assets, like bonds, and lifting their currencies in the wake.
This against a backdrop in which Trump is accusing Europe and China of currency manipulation, with speculation that this may result in him attempting to weaken the dollar. Says ING Global Head of Strategy and Head of EMEA and LATAM Research Chris Turner, “It is possible, Washington may start to look at its own tools to weaken the dollar. There have been no direct suggestions from the White House so far, but tweets regarding the need to match the currency manipulation of other trading partners have the market speculating over whether President Trump would instruct the US Treasury to sell dollars and buy FX in a unilateral intervention.
With such potentially interventionist and unpredictable world leadership right now, it’s little wonder its more difficult than ever to establish the fundamental value of the rand right now or predict where it could be trading six months down the line, let alone a year. So, brace yourself for more volatility in financial markets and expect the unexpected!
"If I have seen further it is by standing on the shoulders of giants" ~ Sir Isaac Newton