Cape Town - Until South Africa exits the World Government Bond Index or there is another external shock, the rand is expected to trade at around R14/$ towards the end of 2017, said Peter Attard Montalto, emerging markets economist at Japanese bank Nomura, in an investor notice.
This is somewhat higher than Nomura’s previous forecast of R15.50/$ in April when the bank predicted the currency would trade around R15.50/$ towards year-end.
Montalto is of the view that there is a strong “asymmetry” in the market, which currently hangs on to every possible positive event as a turning juncture, which results in the rand trading better against the dollar than expected.
“We still fundamentally disagree with this notion (of market optimism) as we expect the status quo to continue through the ANC elective conference in December almost regardless of who wins,” Montalto says, adding that it is likely that Nkosazana Dlamini-Zuma would become the next ANC-leader.
“Clearly there are other scenarios (such as a win by Deputy President Cyril Ramaphosa), but we don’t see it as likely.”
Montalto points out that there have been more consistent rand rallies than sell-offs. In addition, there has been a much more muted market reaction following President Jacob Zuma’s Cabinet reshuffle at the end of March than with Nenegate in December 2015 (when former finance minister Nhlanhla Nene was fired and replaced by Des van Rooyen).
“The rand is in risk-neutral territory (or much more risk-loving than at the height of the Nenegate fall-out period). "This, Montalto says, “suggests to us that political risk premiums are too low.”
Foreign capital flows into South African bonds remain strong, but less so on the equity side. “The spike in net foreign inflows around the time of the (Cabinet) reshuffle meant the market reaction was particularly muted and allowed the rand to continue appreciating shortly thereafter.”
Nomura expects the emerging market asset classes and local debt to continue its strong performance, having risen nearly 11% year-to-date in dollar-terms with prospects for a further 5 percentage points increase. On the back of concerns about growth in developing markets, the lack of global inflation and the possibility of an economic crisis in China, prospects for passive funds in South Africa are positive, Montalto says, even though he thinks South Africa will eventually lose its position on the World Government Bond Index (WGBI).
Shocks to come
Montalto is of the view that the market will finally see the very real threats to South Africa’s economy in the growing political noise in favour of a win for Dlamini-Zuma at the ANC’s December elective conference, another GDP growth shock announcement for the second quarter of 2017 (due in September), as well as debates on the independence of the South African Reserve Bank (SARB) and land reform.
“The market habit of looking at everything as an optimistic turning point we think can only last until a further downgrade comes and then a Team NDZ (Dlamini-Zuma) victory at the end of the year.”
Montalto points out that markets will also realise that a Dlamini-Zuma presidency is not necessarily more positive compared to a Jacob Zuma-presidency.
Nomura is concerned about the independence of the SARB. This follows after Public Protector Busisiwe Mkhwebane called on Parliament to change the Constitution to improve the “socio-economic conditions of the citizens of the republic”, by removing SARB’s mandate to protect the value of the rand.
“We still expect the current leadership of the SARB to fight a fierce battle to protect its institutional integrity,” Montalto says. “The question there is what lies beyond the current terms of its leadership after the second half of 2019.”
Risks for the rand
Nomura says in the event of South Africa exiting the WGBI and another possible credit ratings downgrade after the mini budget in October could lead to an outflow of between $8bn to $9bn and more rand weakness.
“A more disorderly market reaction to the Fed (Federal Reserve) balance sheet roll-off in September could exacerbate rand weakness in the fourth quarter,” Montalto says, “though we would expect any larger global reaction to result in caution by the Fed and so weakness could be short-lived.”
Conversely, a win by (current Deputy President) Cyril Ramaphosa at the ANC’s elective conference in December could see the rand break through the R12/$-level. Montalto, however, points out that a Ramaphosa-presidency won’t result in significant reform and economic growth.