Friday, March 30, 2018 /07:30 AM/BMI Research
BMI View: A multi-quarter rally in the South African rand will come to an end over the coming months, as overly-bullish market sentiment cools. A challenging macroeconomic and political environment, alongside increasingly uncompetitive real interest rates, will see the unit steadily depreciate thereafter.
Short-Term Outlook (three-to-six months)
We believe that the South African rand's ongoing strength will begin to peter out over the coming months, as an interest rate cut and wavering investor confidence begin to weigh on inward flows of foreign capital. Having gained 25.4% against the US dollar since the beginning of 2016, the rally is now showing signs of slowing down; with various technical indicators suggesting a period of greater weakness could follow in the coming months.
The unit's Relative Strength Index strayed into overbought territory in the weeks that followed the election of the pro-reformist candidate, Cyril Ramaphosa, as head of the country's ruling African National Congress. Similarly, the moving average convergence divergence (MACD) indicator shows the 10-day moving average exchange rate having crossed above the 30-day moving average, suggesting the rally has already begun to lose steam, and we expect some depreciation to follow as a result.
In addition to a bearish technical picture, scope for further rand strength is undermined by what we believe was an overly optimistic reaction to Ramaphosa's successful nomination as party president (the unit gained 14.9% against the US dollar in the weeks surrounding December's elective conference according to Bloomberg). Ramaphosa's selection is undoubtedly a positive step towards reform for the region's largest economy, but he will face stiff opposition from traditionalist candidates that have been successfully nominated to other key posts within the party leadership (see 'Ramaphosa Victory No Panacea', December 19 2018). This will opposition will slow the pace of any reform agenda, potentially disappointing foreign investors (see 'Quick View: Split NEC A Headwind For Ramaphosa's Policy Agenda', December 22 2018).
We therefore see a strong likelihood that sentiment towards the rand will sour within the next six months as investors realize they have overestimated the potential for reform under a Ramaphosa-led government. Alongside our forecasts for a final rate cut to come in early 2018, we believe these factors will see the rand depreciate to around ZAR13.1/USD over H118, from ZAR12.4/USD at end-2017.
Long-Term Outlook (six-to-24 months)
Over a multi-quarter timeframe, we believe the rand will continue to face depreciatory pressure due to the unattractive business climate. In addition to the ongoing ideological battle within the ANC, the country's competitiveness remains constrained by powerful labour unions and lackluster economic growth. Unless the reform agenda manages to gain some meaningful momentum, we do not expect foreign investment to pick up in any significant way over the next two years, sustaining downside pressure on the local currency.
In addition to political headwinds to investor sentiment, inflation dynamics look increasingly unfavourable towards further rand strength. Inflation in South Africa fell across 2017, supporting real interest rates on offer to foreign investors. However, with price growth having been kept low thanks to conducive weather conditions producing record harvests, we believe inflation will now increase as the food supply begins to normalize. Increasing real rates in the US will exacerbate the impact on investor appetite for the South African rand, as the yield differential between safe and more risk-laden assets declines.
Finally, with ongoing political risk and falling real yields likely to weigh on investor appetite over the coming quarters, the consistent current account deficits we forecast in South Africa across this period look all the more likely to encourage rand depreciation. The persistence of weak export growth will see South Africa's substantial transfers to the Southern African Customs Union keep the country's current account in deficit, equating to 3.0% and 2.9% of GDP in 2018 and 2019 respectively according to our forecasts. With limited scope for any meaningful inward investment to be sustained over the next two years, South Africa's balance of payments dynamics will likely pose further headwinds to rand strength.
Risks to Outlook
The rand remains highly vulnerable to the country's tumultuous political trajectory over the coming quarters, potentially entailing a substantial degree of volatility in the exchange rate over this period. Key flashpoints we will be watching closely include the ANC's National Executive Committee's statement on President Zuma's future after its first meeting this year, as well as the federal budget and State of the Union address, both delivered in February.