Azar Jammine: Making sense of Rand’s whipsaw – why it is set to drift lower

The past week’s volatility in the South African Rand has been breathtaking. Making sense of it all requires the most rational of minds – so we’re grateful to leading independent economist Azar Jammine for applying his focus onto this confusing matter. The clarity which results is extremely valuable for investor, albeit distressing in that for the moment South Africa is no longer the master of the Rand’s destiny, with the currency being tossed around like a little cork on the ocean. – Alec Hogg 

By Azar Jammine*

Azar Jammine, chief economist, Econometrix

Observers might be forgiven for wondering what has been causing the fairly significant fluctuations in the Rand’s exchange rate over the past fortnight.

Last week the currency recovered ground to trade at levels no worse than they were at the time of the Cabinet reshuffle and subsequent credit rating downgrades at the end of March which generated much anxiety and continues to be the subject of debate as to what its impact is likely to be.

However, this week, especially on Wednesday and Thursday, the currency lost about 5% of its value, only to wipe out a portion of those losses again on Thursday afternoon.

These movements in the Rand had seemingly been unrelated to the continuously volatile domestic political developments which have emerged on an almost daily, if not hourly, basis and which are too plentiful to deal with here.

Moreover, their relevance for currency movements seems to have been quite low. Instead, closer analysis reveals that the Rand’s movements had far more to do with a number of international political/economic developments, especially in the US.

Optimism And Then Concerns About Trump Far More Influential Than Concerns About Zuma

The reason for the Rand’s amazing recovery last week to its best levels since before the credit rating downgrade, with the currency at one point broaching the R13.00 level, was continued risk appetite internationally linked to expectations that the world economy would grow faster in the coming year.

With money flowing into emerging markets, the Rand benefited proportionately more than most other emerging market currencies, repeating its traditional role as a proxy for emerging market investments more generally given the high liquidity of the country’s financial markets.

Funds have shown that amazingly they have been substantial net purchases of South African government bonds since the credit rating downgrade rather than sales.

We have already indicated in a recent bulletin that much of this can be ascribed to the fact that the worst-case scenario in respect of credit rating downgrades, which would see South Africa falling out of the World Government Bond Index, have not yet materialised.

Specifically, S&P and Moody’s have not yet downgraded the rating on South Africa’s local currency to junk status which would precipitate an exit from the Index, forcing large-scale sales of South African government bonds by foreigners.

Nonetheless, the high level of risk appetite towards emerging markets has contributed towards international investors exploiting the 8.5% to 9.0% yields available on South African government bonds, which provide a huge interest rate differential compared with their counterparts in advanced economies.

Conversely, over the past few days, risk aversion on international financial markets has suddenly increased again. This has arisen as a result of the political developments in the US which have seen accusations been levelled at President Trump for sharing intelligence with the Russians and for damaging morale at the FBI by summarily firing the head of that organisation.

Political noise in the US has reached fever pitch in such a way that investors are now concerned that these political developments are diverting Trump’s attention away from implementing the very policies which he claimed would boost US economic growth, viz. huge infrastructural investment, massive tax cuts and financial deregulation.

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In the face of disappointment with the potential progress in generating higher US economic growth, the Dollar has tumbled against the likes of the Euro, Pound and Yen, but risk aversion towards emerging markets has increased even further.

In part this stems from concerns that if US growth does not gain momentum the way it had been expected to do, this will be negative for commodity prices and hence for emerging market currencies of countries whose terms of trade are heavily dependent on exports of commodities like South Africa. Publication of surprisingly weak US economic indicators more recently have added to such concerns.

There was also bad news about Brazilian economic prospects linked to suggestions of corruption yet again by its new president, which knocked the Brazilian real and negatively affected risk appetite for all emerging market currencies.

Gm’s Exit From South Africa Depresses The Rand, But Is Not Due To Ratings Downgrades

On Thursday morning specifically, the Rand depreciated even more sharply than most other emerging markets when it was announced that GM was disinvesting from the country by selling its Struandale plant in Port Elizabeth to Isuzu.

GM is cutting back on its production facilities in SA and pulling the plug on the local Chevrolet brand. (Photo: Supplied)
GM is cutting back on its production facilities in SA and pulling the plug on the local Chevrolet brand. (Photo: Supplied)

The initial reaction was that this move had been inspired by the local political turmoil and represented a classic example of the manner in which investments are being shelved following the credit ratings downgrades.

However, this does not explain why the company is also exiting many of its other African operations. Especially having divest itself from Australia, India and Indonesia in recent years, it makes sense to believe that the decision was made due to global corporate strategic considerations rather than being a result of domestic political developments.

Unfortunately, the development will still be seen in all probability as being a reflection of the growing reluctance on the part of foreign investors to be exposed to South Africa in the wake of politics and the ratings downgrades.

As a result, it might indeed have some negative impact on business confidence, with the knock-on effect on capital investment and domestic economic growth. However, the reality is that the Rand weakened on the back of a global investment decision rather than one driven by domestic politics. Unfortunately, also, we suspect that there will be some job losses as a result of this move, but at the same time it should not be seen as a forerunner of further disinvestment by South African automotive companies.

However, Upbeat IMF Comments Help The Rand To Recover

Just as pessimism was taking hold on the domestic currency market, it received a fillip with the publication of a relatively upbeat report by the IMF.

Amazingly, the organisation revised its forecast for domestic economic growth upwards to 1.0%, from the 0.8% forecast which it had held since October.

Clients may recall that we commented at the time that we believe that the international institution was unduly pessimistic about South Africa’s prospects and have not taken into account the potential benefits of an ending of drought conditions and the decline in inflation which would result from the Rand’s strength. In the event, we were vindicated in our assessment.

The upward revision of economic growth forecast by the IMF contrasts with our own downward revision of our forecast as a result of the credit rating downgrade.

File photo: Visitors are silhouetted against the logo of the International Monetary Fund at the main venue for the IMF and World Bank annual meeting in Tokyo October 10, 2012. REUTERS/Kim Kyung-Hoon

Our own downward revision of growth for 2017 of 1.1% from 1.5% previously now brings our growth forecast much more closely into line with that of the IMF.

The new IMF growth forecast also stands in contrast with the much more pessimistic growth forecasts that have been bandied about in recent weeks in the wake of the credit rating downgrade by a number of banking analysts.

We have maintained all along that the benefits of an ending to drought conditions and recovery in mining output are not liable to be dampened by credit rating downgrades.

Furthermore, the IMF has expressed some hope that the new Minister of Finance Malusi Gigaba will sustain fiscal discipline.

In the event, these comments are likely to be taken to heart by credit ratings agencies in such a way that they will probably be more reluctant for the moment to downgrade South Africa’s credit ratings further.

In other words, the prospect of junk status for local currency debt by S&P and Moody’s, which could have precipitated a large-scale sell-off in the Rand as described earlier, is more distant one than some analysts might have believed.

We Maintain Our View Of An Overall Gradual Depreciation Of The Rand

What these recent events illustrate yet again is the manner in which global developments are far more influential in determining the exchange rate of the Rand than what appear to be extremely volatile domestic political issues.

Mixed denomination rand currency banknotes are arranged for a photograph at a First National Bank (FNB) branch in Johannesburg, South Africa. Photographer: Nadine Hutton/Bloomberg

This is not to suggest that the latter are unimportant and there is some interaction between them and international perceptions.

We remain hesitant about becoming overly optimistic about the prospects for emerging markets linked to global economic developments. On the contrary, we find it amazing that there was so much optimism surrounding Trump after the initial (one-day) shock negative reaction to his election.

We have had huge reservations about the manner in which the new American president would succeed in spending massively on infrastructure and cutting taxes by more than any other president has ever done in an environment in which US public debt is three times what it was 30 years ago as a percent of GDP.

Domestically, also, political noise is likely to reach fever pitch over the next six months in the run-up to the December elective conference.

At the same time the possibility of the worst-case scenario which sees wholesale further credit ratings downgrades and a collapse in the Rand, seems to have diminished.

The combination of these factors points to the most probable outcome for the Rand being a gradual depreciation over time, albeit with short-term volatility, but with the currency declining to no more than R14.50 to the Dollar by the end of the year.

*Azar Jammine is the chief economist at Econometrix

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