The South African Rand: Humbled by Moody's but Standard Bank Reiterates Bullish Forecast

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- ZAR humbled amid fears over Moody's rating.

- Moody's gives thumbs down to Eskom support.

- USD/ZAR crosses 14 level, GBP/ZAR advances.

- Standard Bank reiterates bullish ZAR forecasts.

The Rand fell sharply during the final sessions of trading ahead of the weekend after Moody's warned that a government plan to rescue ailing power utility Eskom is endangering South Africa's credit rating, although Standard Bank is still standing behind its bullish forecasts for the currency.

Moody's warning comes after finance minister Tito Mboweni introduced in parliament on Tuesday a bill seeking approval for an another R59bn of cash injections into Eskom over the next two years, which comes on top of R23bn already approved for each of the 2019/20 and 2020/21 years. 

It's unclear how much funding Eskom actually needs in order to survive, but the impact upon the public purse of the measures announced so far is already significant and threatening South Africa's top credit rating. Some analysts have said the plan could see the nation's budget deficit top the 6% level. 

"If passed, the additional support to ease the company's financial pressures would be credit negative for South Africa because it would be an additional drain on fiscal resources. The lack of a strategy to return Eskom to more stable financial situation that would reduce the need for government support exacerbates the problem for the government," says Marie Diron, a managing director of sovereign risk at Moody's.

Above: USD/ZAR rate at 4-hour intervals, alongside Pound-to-Rand rate (blue line, left axis).   

Eskom has long struggled to keep the lights on for households and businesses due to years of underinvestment in infrastructure and the company provides 95% of all the nation's electricity, which means it's 'too big to fail'. The government has guaranteed more than R350bn of its debt and more recently resorted to pumping cash directly into the company, which is struggling to access financing from the market.

However, President Cyril Ramaphosa's room to maneuver is limited by a high budget deficit, rising debt pile and the watchful eye of Moody's. The government said in February its budget deficit would likely come in at 4.5% of GDP for the 2019/20 year, up from its November 2018 estimate of 4.3% and an increase on the 4% seen in 2018.

Moody's, the last major agency to still have South Africa rated as an 'investment grade' credit prospect, said at the time the budget showed a "further erosion in fiscal strength". It later warned that South Africa's rating could be cut if the government doesn't get its spending, deficit and debt pile under control.

The agency never bought into the government's deficit forecasts back in February and is less pessimistic than the market on the impact the Eskom plan could yet have. It said in February the 2019 deficit would likely be around 5.2% and it warned Friday that this number could rise to 5.7% as a result of the support package but, nonetheless, risks to the rating and the Rand are perceived to be rising by investors and analysts alike.

Above: USD/ZAR rate at daily intervals alongside Pound-to-Rand rate (blue line, left axis).   

"As always seems to be the case these days, it's all about Eskom and the support it needs in the years to come, which is stretching government finances to the utmost," says Deon Kohlmeyer, an analyst at Rand Merchant Bank. "Investors are starting to get nervous despite the large coupon flows at this time of the year and dovish global central banks, which are looking to cut rates and/or pump liquidity into the market." 

Losing the Moody's rating would risk driving the Rand into the ground at least temporarily because it would see many international investors, particularly those who benchmark to the Citi World Government Bond index, automatically forced into selling their government bonds. That would force investors to swap Rand denominated capital back into their domestic currencies. 

President Cyril Ramaphosa and the government are working on a plan to save Eskom that could ultimately see it broken up into three separate operating units, with parts of some of them sold to private investors. However, it's not yet clear whether the plan will be implemented in time, much less sufficient, to spare the public purse from further expense in the name of the struggling company. 

"The prospects of monetary policy easing in developed economies should benefit the rand against the USD, should SA real interest rates remain more attractive than peers. However, the full benefit of lower global rates will likely be diminished by trade tensions, slowing global growth, Brexit, and geopolitical tensions," says Thanda Sithole, an economist at Standard Bank. "The rand also faces several local factors such as poor growth, further fiscal slippage, and ratings downgrades." 

Above: USD/ZAR rate at weekly intervals alongside Pound-to-Rand rate (blue line, left axis).   

Despite concerns at Moody's and in the market about the outlook for the South African rating, not all analysts are downbeat on the prospects of the Rand. Standard Bank, South Africa's fourth largest lender, doubled down behind its bullish Rand forecasts on Friday. 

Standard Bank's Sithole says the Rand is now weak relative to its own historical norms as well as when compared with other emerging market currencies. He's recently described the currency as "undervalued" while other analysts in the industry have flagged South Africa's government bond yields, which in real terms are among the highest in the emerging market world, as being attractive to international investors even after the South African Reserve Bank (SARB) cut its interest rate to 6.25% last week.

"The real trade-weighted rand is now weaker than its dynamic historical trend and also weaker than other EM currencies. It also remains below its arithmetic linear average," Sithole writes, in a note to clients Friday. "The combination of policy reforms in SA, and our G10 strategist’s view of a weaker USD by year-end, informs our constructive rand forecast which remains within the fair-value range of our econometric model."

Sithole forecasts the USD/ZAR rate will end 2019 at 13.80, down from the 14.16 level that prevailed on Friday. 

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