ABSA: South African Rand at Risk of MSCI Equity Index Shake-up

Image © Richard Atkinson, reproduced under CC licensing

- Rand could be hit by re-weighting of index

- New weighting to favour Chinese shares at expense of SA

- ZAR could fall between 2%-5% at end of May

The South African Rand is at risk from an imminent re-weighting of a major emerging market share index so that more Chinese shares are included at the expense of SA shares, according to analysts at ABSA, South Africa's largest lender.

Many global investors simulate the composition of their portfolios on the constituents of the MSCI index since it is a respected benchmark for quality equities, so the reweighing will have a profound impact resulting in many foreign investors ditching the SA shares which are excluded from the index, and, therefore, high outflows from the Rand.

The MSCI Emerging Market (EM) Equity Index represents shares from 24 EM countries and includes both mid and large capitalised companies. It has 1,138 constituent shares and covers approximately 85% of the free float-adjusted market capitalisation in each country.

As a direct result of the MSCI reweighing ABSA expect the Rand to fall by 2.0% versus the U.S. Dollar, based on market responses to previous re-weightings.

“Based on the SA’s equity outflows in the months of the last MSCI re-weightings, passive investors will likely sell between USD1.5bn to USD3.0bn worth of JSE-listed shares at the end of May, which poses an upside risk to our ZAR14.50/USD mid-year target,” says Peter Worthington, an analyst at ABSA.

Above: MSCI performance benchmarks

Although the Pound is weakening substantially as a result of heightened Brexit risks, s similar 2.0% fall in GBP/ZAR could result in the exchange rate falling from 18.25 (the rate at the time of writing) to 17.87 (assuming a neutral sterling).

But the declines could be even bigger if - as ABSA expects - a general climate of global risk aversion continues to overshadow markets. In such a scenario they see the sell-off leading to as much as a 5.0% decline in the Rand.

The sell-off is expected to peak at the end of May, after the 29th.

“Specifically, we believe the ZAR will weaken by 2% against the USD, but if global risk aversion is high on 29 May, due to factors such as heightened global trade tensions, resultant ZAR depreciation could be closer to 5%,” says Peter Worthington.

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