The South African Rand is Tipped as a Sell ahead of October's Budget 

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- USD/ZAR tipped as a buy at UBS ahead of October budget. 

- Says market underprices "fiscal slippage", eyes ZAR losses.

- Investec warns of volatility ahead of Nov Moody's decision.

- Sees outlook changed to negative on deficit, debt trajectory.

The Rand made solid gains this week but is being tipped as a sell by at least one major bank ahead of the October 29 budget, while local analysts are warning of volatility heading into the November 01 Moody's rating decision.

South Africa's Rand advanced 1% against the Dollar this week, with half that gain coming Friday amid reports the U.S. and China made progress with efforts to firm up the "phase one" deal the White House claimed was already struck on October 11, easing concerns about the prospect of the pact disintegrating before it's ever even recorded in writing. The last minute burst of optimism helped the Rand cement gains made earlier, off the back of Dollar weakness.

However, and on the downside, the Rand is now tipped as a sell by strategists at UBS. They say the markets aren't fully prepared for the degree of 'fiscal slippage' UBS anticipates in the October budget. Finance Minister Tito Mboweni will update parliament, the world and ratings agencies Wednesday although after announcing another bailout for ailing electrictity provider Eskom earlier in the year, the public finances are expected to have deteriorated significantly. 

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

"UBS Strategy expect rand’s underperformance relative to high carry peers (RUB, IDR, MXN) to continue as they believe the currency does not fully price in the degree of fiscal deterioration expected by year end," says Chrissie Loedolff, a multi asset class salesperson at UBS. "With positioning a lot cleaner, potential further negativity out of the budget next week and possible Moody's downgrade, current levels in USDZAR offers good risk reward to buy."

The UBS team has a number ideas about how to capitalise on movements in the USD/ZAR rate next week and all are geared toward being on the right side of anticipated weakness in the Rand. The bank says Wednesday's budget, which comes just two days ahead of an important ratings decision from Moody's, could spook the Rand because it's unlikely to yield any positive news. 

South Africa's government said in February that its budget deficit would likely be around 4.2% of GDP this year and 4.5% the following year, which was already bad enough for the ratings agencies Moody's, only those numbers are now likely to have moved much higher thanks to more than Rs59 bn of cash injections that were announced for Eskom earlier this year. The bailout runs over a two year period but will cost South Africa up to an extra 0.6% on the deficit each year. 

"The rand will remain volatile, with the resolutions to the Eskom crisis, security of electricity supply and alleviating pressures on economic growth all key. SA is likely to see Moody’s downgrade the country outlook to negative post the MTBPS, signalling a credit rating downgrade will occur unless the escalation in the debt trajectory is halted," says Annabel Bishop, chief economist at Investec.

Above: USD/ZAR rate shown at daily intervals.

South Africa's debt has crossed above 60% of GDP and the budget deficit is still rising although there is still one major credit rating agency that has the country as an 'investment grade' prospect, Moody's, although it's heavily criticised the government this year for the worsening of its finances and a lack of effective action to correct them, still has a positive outlook on the ratin. It said recently it would likely change that before issuing a downgrade, but this won't necessarily spare the Rand Friday.

"Eskom’s sheer quantum of debt is an ongoing concern to financial markets, with the speedy resolution of the entity’s debt crisis critical to restoring investor confidence in South Africa (along with security of supply), Bishop says. "Government’s consolidated budget deficit forecast will likely have widened substantially in 2019/20 (we believe to around -6.0% of GDP), partly due to the additional allocations to Eskom this year."

President Cyril Ramaphosa has sought to put right the public finances since ascending to the Mahlamba Ndlopfu in February 2018 only his efforts are now being frustrated by the sickly state of Eskom, which is a burden made worse by its inability to keep the lights on for South Africa. The government is on the hook for around Rs450 bn of debt, none of which it can afford to repay. That's making an already precarious taxpayer balance sheet even more stretched while testing the patience of Moody's.

A loss of the 'investment grade' rating would see investors, particularly those benchmarking to the Citi World Government Bond index, forced into selling their bonds which would mean large outflows of capital from South Africa. Investec says Moody's could put South Africa on 'review for downgrade' and change the outlook on the rating to negative, which would be sure to wound the Rand. Market fears about Moody's actions on Friday are why the UBS team is telling clients to buy the USD/ZAR rate.

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