ABSA: Pound can go Higher Still vs. South African Rand

© Richard Atkinson, reproduced under CC licensing

- GBP/ZAR finds support at 18.30 and recovers

- The pair surges higher after the budget statement

- Rand weakens on government financials

Technical studies suggest the Pound-to-South African Rand rate has probably started a new longer-term uptrend after the pair rose from the key October lows at circa 18.30 while the country's largest lender ABSA sees further GBP/ZAR upside.

The catalyst for the recent rally in GBP/ZAR was the publication of the South African medium-term budget, which projected a worsening deficit due to lower revenues and higher spending, and weighed on the Rand. The Pound went from buying 18.50 Rand to 18.75 by the end of the day.  

The pair has formed a distinctive level of support in the 18.20-30s which it has touched and rebounded off twice in October.

It also means the level of the October lows will probably provide tough support and resistance in the future.

The Pound is likely to continue to rise against the Rand as the year progresses, according to forecasts from South African-based ABSA bank, who expect GBP/ZAR to reach 18.67 by the end of December 2018, and 20.59 by the end of 2019.

The Medium Term Budget Policy Statement (MTBPS) was presented by the new finance minister Tito Mboweni on Wednesday, October 24, and has stoked concerns about the SA economy because it forecasts a widening budget deficit due to an increasing revenue shortfall.

The South African treasury's revenue shortfall will go from R27.2bn (£1.4 billion) in 2018 to R24.7bn in 2019 and then back up to R33bn in following years.

This translates into an estimated budget deficit of 4.0% in 2018, 4.2% in 2019, and then  4.0% in subsequent years.

It marks a significant deterioration from the projections reported back in February when the budget deficit was expected to fall from 4.3% in 2017, to 3.6% in 2018 and then stabilise at 3.5% in 2020.

The GDP growth forecast assumption used in the budget calculation was also downgraded, but even the revised estimates were "still too high," says Absa, who see growth as slowing more dramatically.

"The MTBPS adopted a weaker macroeconomic backdrop as expected, but we think the National Treasury’s nominal GDP projection could still be too high, in our view," says Peter Worthington, an economist at ABSA.  

A wider budget deficit will make the country more reliant on outside financing to meet its borrowing needs. The country's current account deficit also requires outside funding.

This makes the country reliant on foreign investors to fund the shortfall.

This is not a strong fiscal position to be in and makes SA vulnerable. It affects stability because foreign investors tend to demand higher compensation for their risk compared to domestic lenders, are more fickle and the loans are often subject to FX risk.

The country already has a heavy reliance on outside funding which is behind the reason why it was so badly hit by the appreciating Dollar during the last crisis. Much of its debts are denominated in USD, making it vulnerable to rises in the US currency because it pushes up the cost of repayments.

"Gross loan debt is now projected to hit 55.8% of GDP by the end of the current fiscal year vs the 55.1% projection in the 2018 Budget. The National Treasury said that 70% of this deterioration is due to the weaker rand," says Worthington.

The Rand will weaken but not excessively, says Absa. Fears that credit rating agency Moody's might downgrade the country are overdone and unlikely to materialise.

"The rather dismal MTBPS would seem to raise the risk that Moody’s changes the outlook on its Baa3 credit rating back to Negative.

However, we think the agency is likely to see South Africa through next year’s general elections before changing the rating," says Worthington.

The credit rating agency declined to downgrade the country in 2017 when many people feared it would. The disposal of the previous president Zuma and replacement by more reform-minded Cyril Ramaphosa was seen by many as the reason Moody's held back from downgrading SA to sub-investment grade.

Markets have soured since Ramaphosa's election, however, as disappointment has set in the new president does not seem to have built on his promises, and economic woes continue unabated.

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