- The South African rand has become one of the best-performing emerging-market currencies over the past eight weeks
- But the risk remains high of a significantly weaker rand during the second half of the 2021
- IHS Markit expects the South Africa rand to sustain current value of close to ZAR14.10–14.30:USD1.00 until mid-2021
IHS Markit Analyst - Thea Fourie
The South African rand’s strengthening exchange rate has made it one of the best-performing currencies in emerging markets so far this year, but the risk remains high of a significantly weaker rand during the second half of the 2021.
The South African rand has become one of the best-performing emerging-market currencies over the past eight weeks, recouping more than 10% of its value against the US dollar compared with a year earlier. This leaves the value of the rand at close to ZAR14.10:USD1.00, from the 2020 low of ZAR20.63:USD1.00.
A chain of events has contributed to the rand’s exchange rate resilience, most of which factors are expected to support the currency over the short term. Periods of US dollar weakness as the coronavirus disease 2019 (COVID-19) pandemic and vaccine rollout unfolds, resilient commodity prices, favourable political and key fiscal developments in South Africa, and a strong current-account performance underlined the rand’s strength in recent months.
The rand’s exchange rate against the US dollar has mirrored euro–US dollar performance since 2018. The period ahead of the COVID-19 pandemic saw the euro weakening against the US dollar, with the rand’s exchange rate following suit. At the height of the COVID-19 uncertainty in early 2020, the US dollar’s ‘safe haven’ status supported the currency further, leaving most emerging-market currencies, including the rand, vulnerable against the greenback. Since then, the euro and the rand have made up some of their losses against the US dollar but remained above pre-pandemic levels in early 2021. The large fiscal stimulus announced in the US economy has moved interest rate differentials in favour of the US dollar and stalled some of the euro’s appreciation. IHS Markit assumes, however, that various factors will support long-term euro appreciation. These include the still relatively low level of the euro against the US dollar compared with historical peaks and the persistent and large current-account surplus in the eurozone, which has exceeded 3% of GDP since 2014. This outlook bodes well for medium-term projections of the rand’s exchange rate, but short-term euro vulnerability should not be ruled out as the growth and interest rate gap between the United States and the eurozone widens.
South Africa remains a commodity-dependent economy and the recent resilience in global commodity prices bodes well for the country’s external accounts and exchange rate. In fact, South Africa recorded a current-account surplus of 2.2% of GDP in 2020, the first annual surplus since 2002. Global commodity price resilience is expected to support South Africa’s balance of payments and the rand’s exchange rate for the remainder of 2021. The IHS Markit Materials Price Index (MPI) has doubled since March 2020, with commodity prices collectively now at their highest level since 2014. Several factors explain the rise: strong mainland Chinese demand, a shift in household consumption expenditure toward goods, a weaker US dollar, generous government stimulus, vaccine optimism, and pandemic-related disruptions of supply chains. The magnitude of commodity price gains could slow somewhat during the second half of 2021. Assuming the disruptions and bottlenecks that have plagued supply chains during the past year are resolved speedily as the pandemic recedes, better balances are expected to develop in markets with cost pressures dissipating. However, global commodity prices are expected to remain rand supportive in the near term.
Furthermore, the rand draws support from key fiscal and political developments in recent months. On 3 May, the ruling African National Congress (ANC) party’s secretary-general, Ace Magashule, was formally suspended by the party’s National Executive Committee (NEC). This followed a decision by the NEC on 29 March to give all party members that face criminal charges 30 days to withdraw from their elected positions or face suspension. Magashule’s suspension is a key development favouring government policy implementation because he is the most senior political rival within the ruling party of current party president and national president Cyril Ramaphosa. Magashule’s suspension will weaken the faction of the ANC that has resisted Ramaphosa’s efforts to introduce sweeping market-friendly reforms. Furthermore, in late March, South Africa’s national treasury announced that a revenue overrun of ZAR38 billion (USD2.7 billion) is possible for fiscal year 2020/21 and will the leave the fiscal deficit of 14% of GDP below initial projections. The market draws some support from the fact that South Africa’s fiscal backdrop has not worsened in the short term, although fiscal finances remain in a highly precarious position. The positive sentiment was supported by a decision by international rating agency Moody's Investors Service on 7 May to skip South Africa’s latest credit risk assessment, which ultimately leaves South Africa’s sovereign ratings unchanged at this stage. Moody's currently rates South Africa at Ba2 (equivalent to BB on the generic scale and 47.5/100 on the IHS Markit scale), in the Likely to Fulfil Obligations category, with a Negative outlook. IHS Markit’s medium-term sovereign risk rating is below that of Moody’s and is set at 55/100 (Ongoing Uncertainty) with a Stable outlook.
On balance, IHS Markit expects the South Africa rand to sustain current levels of value of close to ZAR14.10–14.30:USD1.00 until mid-2021. At current levels, IHS Markit’s purchasing power parity (PPP) estimates suggest that the rand’s exchange rate is overvalued, with a fair value closer to ZAR14.85:USD1.00. The risk of short-term euro weakness, a slowdown in global commodity price gains, and a swing towards a current-account deficit as domestic economic activity in the South African economy accelerates could leave the rand slightly weaker against the US dollar during the second half of 2021, at levels closer to ZAR14.60–14.85:USD1.00. Furthermore, IHS Markit expects that fiscal finance concerns will re-emerge as the year progresses. Government spending is expected to remain vulnerable to the long-standing inability to control an ongoing push for higher public-sector wages and calls for government support to ailing local authorities and state-owned entities, such as the South African Airways, Denel, and power provider Eskom, especially ahead of the upcoming local elections later in the year. Further sovereign rating downgrades deeper into sub-investment territory and growing pressures on debt sustainability are inevitable unless public-sector debt accumulation is reversed rapidly.
IHS Markit also acknowledges, however, that the outlook is subject to a large degree of risk. Global commodity price trends combined with rising global inflation and associated interest rate developments are the biggest risk factors in the near term. Stronger global commodity prices for longer will be rand supportive, but global inflation surprises to the upside could bode negative for the rand over the period.
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