Pound-Rand Exchange Rate: Moody's Downgrade Fears, Rising Cost of CDS and Coronavirus all Weighing on ZAR

- Rand weakness has more than Coronavirus to blame
- Concerns rise that SA could default on its debt
- Investec say Moody's downgrade now a 50/50 event

Image © Pound Sterling Live

- GBP/ZAR spot: 19.02,  +0.75%

- Indicative bank rates for transfers: 18.35-18.48

- Indicative broker rates for transfers: 18.50-18.84 >> find out more about this rate.

The South African Rand is a notable laggard on global foreign exchange markets at the start of the new week, with the currency being weighed down by global risks in the form of the Coronavirus outbreak in China and rising anxieties as a critical Moody's ratings decision approaches.

"While global market players have shown some risk aversion on worries about the spread of the coronavirus, SA’s increasing risk of a Moody’s downgrade is proving a dead weight for the domestic currency," says Annabel Bishop, an economist at Investec in Johannesburg.

Rand weakness is the key engine behind the Pound-to-Rand exchange rate's jump back above the 1.19 level at the start of the new week; the exchange rate had been as low as 18.75 on Friday before the latest bout of ZAR selling.

The Dollar-Rand exchange rate is over a percent higher at 14.53, having been as low as 14.27 last week, meanwhile the Euro-Rand exchange rate is at 16.03 with the exchange have been as low as 15.80 last week.

The Rand would typically be expected to underperform in an environment where global stock markets and commodity prices are deep in the red, as is currently the case owing to growing expectations that the Coronavirus outbreak in China will hit economic activity in the world's second-largest economy.

Above: The Rand is underperforming a host of its emerging market peers, suggesting that it has its own domestic issues to worry about

"The ZAR is under pressure amidst emerging market volatility and broader risk-off sentiment. The market is also gearing up for the upcoming budget and Moody’s review that is likely to result in SA becoming sub-investment grade," says Bianca Botes, Treasury Partner at Peregrine Treasury Solutions.

China reported 2,051 cases in 30 provinces on Sunday, which is a 50% increase on the day before while the death toll currently stands at 81. The assessment by markets is simply that authorities do not yet have a grip on the outbreak and therefore quantifying its economic cost is not yet possible.

The economic impact of the virus will initially be felt in travel-related and retail industries, as we note here. The Chinese government has already banned all group tours from travelling outside the country, beginning Monday. Tens of millions of Chinese travel abroad during the lunar new year holiday, which began this weekend, and bans such as this will likely knock economic activity.

Why Coronavirus Matters for the ZAR

China is a key destination for South African exports, and therefore any expectation for an economic slowdown in China will ultimately impact South Africa's foreign currency earning power, and by extension the Rand.

Wall Street is trading 1.52% in the red, the FTSE 100 is down 2.24% and the JSE is down 2.4%.
WTI oil prices fell 3% while copper is down 1.80%.

"The speed at which the virus is spreading is a likely catalyst for volatility this week, manifesting in equities losses and commodities price swings," says Nema Ramkhelawan-Bhana, analyst at RMB Global Markets.

Under current conditions we would expect the Rand to suffer; however we are also acutely aware that such public health scares are ultimately short-lived and therefore there is scope for markets to recovery rapidly as soon as China can indicate in a convincing manner that it has gained the upper hand on Coronavirus.

Moody's Downgrade Fears to Anchor ZAR

However, for the South African Rand any post-Coronavirus recovery might ultimately be limited by poor sentiment regarding the outlook for the domestic economy.

"Emerging Market currencies are weaker in general, but the Rand has been most negatively affected as concerns over SA’s debt projections raise fears of a Moody’s downgrade, volatility has increased for the Rand. Markets are also factoring in a greater chance of a downgrade as South Africa’s CDS has climbed to 178, from 159 at the start of the year," says Investec's Bishop.

CDS refers to Credit Default Swaps which are products taken out by investors to insure against a borrower going bust; the higher the CDS, the more in demand it is and therefore it betrays growing expectations that a borrower will struggle to repay their debt in the future. In this instance, the cost of insuring against the South African government failing to honour their debt is going up.

These concerns are growing as the economy continues to stutter, and if the situation deteriorates it becomes ever hared for the Government to realise the revenues required to service its debt.

The quality of South Africa's debt will be reviewed at Moody's on March 27 2020, and a downgrade could result in a sizeable exodus in foreign investor holdings of SA debt, an outcome that would place significant downside pressure on the Rand as capital flows out of the country.

Investec say they have increased their expectations of a Moody’s downgrade to almost 50/50 in light of the evolution of the country's economy.

The Moody's decision will ultimately be swayed by the Government's spend and tax plans for 2020, which will be laid out at the February 26 budget, and Investec say there is no certainty that the necessary expenditure cuts will be delivered by the treasury.

"S.A debt outlook and a likely Moody's downgrade is testing ZAR resilience," says Peter Stoneham, an options analyst at Thomson Reuters, "ZAR weakness is likely to hold into the key February S.A budget."

Investec meanwhile retain a base case (only 39% probability, mind you) expectation that South Africa will avoid a Moody's downgrade, and that the country's annual growth will recover to 2.0% by 2021.

Under such a scenario the Rand is expected to end the year close to where it is now, with USD/ZAR ending the 2020 at 14.45.

The GBP/ZAR exchange rate is forecast to end the year at 19.21 under the base-case scenario, with EUR/ZAR closing at 16.62.

However, a Moody's downgrade is the next most likely scenario held at Investec with a 38% probability. Under such an outcome a recession could occur, and USD/ZAR ends the year at 16.10, which duly pushes the other cross exchange rates higher.

How the economy emerges from such an outcome does ultimately depend on how quickly the government is able to repair the ailing economy, with a specific emphasis being placed on resolving issues at the state power utility Eskom.

"The risk is not just that SA will receive a Moody’s credit rating downgrade this year, but that SA will continue to receive downgrades from the three key rating agencies, falling from highly speculative to the substantial risks category of C grade, and onwards to the ‘default imminent with little chance of recovery” credit rating category (IMF bailout territory)," says Bishop.