The Rand Is at Risk as Fresh Eskom Woes Threaten a Three-quarter Recession

Image © Government of South Africa, reproduced under CC licensing

- ZAR steadies after Iran linked sell-off last week.

- But the ZAR's honeymoon might not last for long.

- As Investec eyes three-quarter recession for SA.

- Tips fresh USD/ZAR and GBP/ZAR gains for 2020.

- Eskom resumes load-shedding amid capacity woes.

The Rand steadied on Monday after an Iran-related sell-off brought an end to a strong run of gains late last week although South Africa is now facing a three-quarter-long recession due to load shedding at Eskom, according to economists at Investec who forecast fresh losses for the year ahead. 

South Africa's Rand rose against the Dollar and managed to limit gains for a rampantly strong Pound Sterling to just 0.06% on Monday as investors renewed their bids for many emerging market currencies even as other risk assets like stocks continued to fall amid mounting tensions between the U.S. and Iran. 

Asian currencies exposed to the strategic bottleneck that is the Strait of Hormuz in the Gulf remained on the back foot Monday but many other emerging market units including the Rand, Mexican Peso, Brazilian Real and Russian Rouble all advanced on the Dollar early in the new week.

Seasonal factors, not to mention an eagerly anticipated U.S.-China trade deal, could keep the South African unit afloat for a while yet but Investec says the risks are to the downside for the Rand. 

Above: USD/ZAR rate shown at hourly intervals. 

"Risks appear slightly more poised to the downside with the recent heightened US military aggression in the Middle East, generating some volatility in a typically calm period for EM currencies," says Annabel Bishop, chief economist at Investec. "Indeed, this year and next, SA risks at least one severe supply-side recession just as the risk of a global supply-side recession on the US-led trade war may be receding on the expected phase-one trade deal with China."

New Year periods often see emerging market currencies supported by seasonal factors and this year is expected to be no different especially with the U.S. and China getting set to sign the 'phase one deal' to temporarily end the trade war between them on January 15. That tariff conflict has wounded the global economy, lifted the safe-haven Dollar and crushed emerging world currencies through the best part of the last two years.

However, storm clouds are gathering over the South African economy, which already contracted in the third-quarter of 2019 so is just one quarter away from its second technical recession in as many years. Load shedding at the national power utility Eskom, which sees rolling blackouts imposed upon the country's companies and households, became so severe in recent weeks that Investec now forecasts an economic contraction for the final quarter. 

"Substantial load shedding in Q4.19 reached previously unattained stage six, and is expected to have damaged economic production, with GDP likely contracting in excess of -1% qqsaa in Q4.19. Further load shedding is expected in Q1.20, which would support a further contraction in GDP," Bishop warns in a note sent to clients on Monday. 

Above: Pound-to-Rand rate shown at daily intervals. 

Eskom announced late Sunday it was moving imminently from stage 4 load shedding to stage 6 after having moved from stage 2 to stage 4 earlier in the day. Each incremental stage of load shedding sees 1,000MW of power dumped from the grid although at stage six, the 6,000MW loss is equivalent to around 30% of total South African daily demand for electricity. 

The over indebted and insolvent company relies on continuous support from the tax payer to stay in business and is the biggest threat to South Africa's investment grade credit rating. It told President Cyril Ramaphosa in December that no further load shedding would occur before mid January and Ramaphosa duly repeated the claim to the electorate after having cut short an overseas trip to investigate earlier load shedding and claims of sabotage by the company. 

"The first quarter of each calendar year has seen a contraction in GDP in the past four years, and Q1.20 is expected to be no different. However, Q4.19 GDP likely contracted as well, while Q3.19 saw GDP contract by -0.6% qqsaa. This would see three successive quarters of contraction in GDP," Bishop says. 

A shrinking economy will automatically increase South Africa's debt-to-GDP ratio even before the government gets to paying the increased welfare benefits and counting the lower taxes that almost always accompany economic woes of any kind. And such developments would hardly be welcomed by Moody's, the last major agency to still rate South Africa an 'investment grade' borrower, which has already cut the outlook on the rating from stable to negative.

Above: USD/ZAR rate shown at daily intervals. 

Moody's will announce its next rating decision in late February after the government's next budget plan and updated estimates for tax reveneus, borrowing, spending and economic growth are unveiled. Any decision to cut South Africa's rating to 'junk' would risk encouraging outflows of foreign capital from the country and could lead to a substantial depreciation of the Rand.

Bishop and the Investec team forecast the Rand will depreciate steadily against the Dollar and Pound over the course of 2020, with the steepest losses coming between March and September. The bank tips a USD/ZAR rate of 14.30 for the end of March, up from Monday's 14.22, although the exchange rate is seen rising to 14.60 and 14.80 for the respective second and third quarters. 

The Pound-to-Rand rate is seen rising from 18.71 Monday to 18.75 in March, 19.07 in June and 19.26 in September, although it and the USD/ZAR rate are expected to pare back those increases in the final quarter.

The USD/ZAR rate is seen ending 2020 at 14.45 while the Pound-to-Rand rate is expected to finish the year at 19.21.

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