A five rand coin. Picture: REUTERS
A five rand coin. Picture: REUTERS

Remember the "flash crash" two years ago that took the rand close to a record of R18/US$, R23/£ and almost R18/€? It was the point when some doomsday commentators gave up on SA, invoking a future where the rand slid rapidly to R20/$ as the country lurched into anarchy and decay.

At the time it was normal to see the rand rated as the worst performer globally and the country listed as among the emerging markets most vulnerable to the global sell-off that was under way.

So South Africans should be forgiven for feeling some elation at the rand powering back to R11,86/$ last week — its strongest in almost three years. It has also managed a respectable R16.81/£ and R14.72/€.

Rand Merchant Bank currency strategist John Cairns had expected the rand to strengthen to R12.50/$ if deputy president Cyril Ramaphosa won the ANC election in December and to reach R12/$ only by the end of this year.

"So it has done a lot better than we thought," he says. "We got there on January 24."

Apart from SA’s toxic politics, the bulk of the rand’s weakness over the past few years has been due to two mutually reinforcing global trends: a strong dollar cycle and a weak commodity cycle.

Both of these cycles have since turned, allowing the rand to benefit from a weak US dollar environment, rising commodity prices and bullish sentiment towards emerging-market assets in general.

The US dollar is at a three-year low, having lost a further 2% of its value so far this year on top of the 10% decline it experienced in 2017.

Analysts say the dollar is weakening on political dysfunction and policy confusion in Washington, including concern over a possible government shutdown on February 8 due to a budgetary deadlock, and doubts about Washington’s commitment to a strong currency.

Ongoing worries over tougher US trade restrictions aren’t helping. Last week the country placed tariffs on imported solar panels and washing machines. The latter will raise the cost of some appliances by as much as 50%.

"US dollar weakness boosts commodity prices and, as the rand is a commodity currency, this in turn supports rand strength," explains Investec economist Annabel Bishop.

Commodity prices, particularly those of metals, are soaring, with coal reaching a five-year high of $100/t and gold and platinum coming close to their best levels in the past year.

The Economist’s commodity-price index has risen by 20% since falling to an almost seven-year low in January 2016.

All commodity currencies have benefited from these global shifts. However, only the Mexican peso has outperformed the rand this year. This suggests that part of the rand’s gains must be SA-specific.

Cairns believes as much as 75% of the rand’s gains since December are a result of domestic developments, specifically the surge in positive sentiment generated by Ramaphosa’s ANC election victory.

And instead of that confidence waning on subsequent political infighting and policy inertia (though it is still early days), Ramaphosa seems to be just getting into his stride, judging from his warm reception at the World Economic Forum in Davos last week.

Goldman Sachs’s suggestion that SA could become the hot emerging-market story of 2018 appears to have gained some traction in Davos, and people were eager to hear from SA’s new president-in-waiting.

There was standing room only at the annual SA Davos dinner, and private investors at the Swiss resort reportedly swamped trade & industry minister Rob Davies with plans for new projects, including a $300m new automotive plant and an offer of $25bn for infrastructure from a Southeast Asian sovereign wealth fund.

Attending his eighth Davos meeting, Business Leadership SA CEO Bonang Mohale said the atmosphere in the Team SA camp was like "chalk and cheese" compared with previous years, "when we had lost our shine".

The SA delegation consisted of 54 people, including a raft of cabinet ministers and leading CEOs.

Ramaphosa charmed the global financial community with his message of renewal and commitment to tackle corruption.

Ashburton Investments head of fixed income Shalin Bhagwan says Ramaphosa’s message in Davos was essentially: "SA is back, possibly from the brink, but from here on count on us to get stronger, better, faster."

He promised stronger governance through a resolute focus on stamping out corruption as well as stronger relations between government and business; better accountability to the people of SA; certainty of government regulatory policy; and faster progress in achieving the country’s goals.

"The markets are liking what they see in the man — his clarity of thought and purpose, his seriousness, and the actions he has taken over the past two weeks," says Mohale.

These include the announcement of a judicial commission of inquiry into state capture; the Asset Forfeiture Unit’s freezing of certain ill-gotten gains; the prosecuting authorities’ move on Gupta interests and ANC politicians linked to the Free State dairy farm scandal; and the appointment of a new, highly credible Eskom board.

"These are all things we couldn’t achieve in the past six years," says Mohale, "What business wants is what [Ramaphosa] wants."

The market’s perception that SA’s credit risk is improving is reflected in the narrowing of SA’s credit default swap (CDS) spread, from close to 200 basis points before the ANC December elective conference to 144bp now, just below Turkey, which is at 164bp. Prior to the conference, SA’s CDS spread was roughly in line with Turkey’s.

The problem is that SA’s growth and fiscal challenges will not easily be overcome this year, and there remains a better than even chance that Moody’s will junk SA’s last credit rating next month after finance minister Malusi Gigaba delivers a reality check with a brutal, growth-sapping budget.

At Davos, Gigaba said he was confident that a rating downgrade could be avoided. He promised a tough budget that would stabilise the country’s mounting debt ratio. This meant South Africans would have to "bear some pain", he said, suggesting that significant tax hikes were on the cards.

However, while better debt metrics would help inspire confidence about government’s commitment to fiscal discipline, this has to be matched with the announcement of structural reforms that will unlock faster growth. Or SA’s fiscal problems will continue to mount.

After meeting Ramaphosa in Davos, IMF MD Christine Lagarde said both she and Ramaphosa had agreed that longstanding structural challenges continue to weigh on SA’s growth and that "bold and timely reforms" are needed to create an environment conducive to job creation and less inequality.

"Recent initiatives to improve governance and strengthen public institutions are steps in the right direction," she added. "These efforts need to be sustained and complemented both by fiscal policies that stabilise debt at manageable and sustainable levels, and by the re-establishment of business confidence to make the economy more productive and competitive."

Despite the favourable global backdrop, SA’s challenging domestic fundamentals suggest that the rand should be trading at only around R13.80/$ this quarter, according to Absa’s valuation models.

Mike Keenan, a fixed income strategist at Absa Corporate & Investment Bank, points out that while the rand’s overshoot is by no means unprecedented, the currency has rarely managed to sustain bouts of strength in the past.

He expects the rand to end the year considerably weaker, at R14.10/$, R17.34/€ and R19.10/£.

"We would become more constructive about the rand if our GDP assumptions improve, we avoid a Moody’s downgrade, Fed rate hike fears subside and/or portfolio inflows towards SA accelerate," he says.

He believes Moody’s is more likely than not to downgrade SA’s local currency rating unless the upcoming February budget outlines significant fiscal consolidation.

Such a downgrade would automatically eject SA bonds from the World Government Bond Index, which could result in up to $8bn worth of portfolio outflows from SA, according to Keenan’s estimates.

Cairns, on the other hand, expects the rand to strengthen even further as it builds on its own momentum and as the dollar continues to weaken.

However, he also fears that the rand could struggle at the February budget and subsequent Moody’s review, as well as perhaps at year-end, should the Fed tighten policy as expected.

Even so, Rand Merchant Bank’s year-end forecast leaves the rand much where it is now, at R12/$, R16.32/£ and R14.16/€.

Standard Bank economist Elna Moolman is also bullish. She expects the rand to end 2018 at R12.50/$ and to be just marginally weaker at R12.70/$ by the end of 2019.

"Our rand forecasts are constructive, supported by benign global economic expectations, including reasonably strong economic growth and the expectation that capital flows into emerging markets will remain robust," she says.

Domestically, improved sentiment about the political economy should also provide material support to the rand, she feels. In addition, the rand is likely to benefit from a relatively small foreign funding requirement, given her expectations that the current account deficit should widen only modestly this year.

However, Moolman will be monitoring several rand risks closely, particularly towards the second half of the year.

Her chief concerns are that China could slow down more than foreseen and that higher inflation in advanced economies (notably the US) could compel faster than expected monetary policy normalisation by major central banks.

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