South African Rand Outperforms Amidst Fading Coronavirus Fears, Ratings Downgrade to Limit Upside

- ZAR outperforms as Coronavirus fears ease
- Ratings downgrade looms large on horizon
- Investec

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The South African Rand is recording gains at the start of the new week as global markets bet that the coronavirus outbreak is close to peaking, however an analyst at South African lender Investec says the Rand remains at risk of triggering new multi-year lows.

The Rand is being driven by a combination of global risk sentiment, currently linked to the 2019 Novel Coronavirus (2019 nCoV) outbreak and growing expectations for a rate cut to be delivered by Moody's in the wake of March's South African budget report.

More than 17K confirmed cases of Coronavirus have now been reported in China to date, with approximately 361 people having died according to official statistics. Outside of China, more than 150 confirmed cases of the virus have been confirmed, with one death occurring in the Philippines.

"The Rand reached R15.00/USD on global financial market risk-off, as the spread of the 2019 Novel Coronavirus has seen the Rand the worst performer since the middle of last week, as it is seen as a proxy for other EM currencies and for risk," says Annabel Bishop, Chief Economist at Investec Bank Limited South Africa.

Rand weakness was particularly apparent against Sterling, which rallied sharply into month-end on the back of a decision by the Bank of England to keep interest rates unchanged at a time some in the market were expecting a rate cut:

Above: The Pound-to-Rand exchange rate breached new multi-year highs last week.

However, the South African Rand is outperforming its rivals on Monday February 03 amidst signs that the Coronavirus outbreak is plateauing. Those currencies that stood to gain the most from the outbreak - such as the Yen and Swiss Franc - are understandably laggards under such an outcome.

"Compared with the SARS outbreak in 2002-03, the Chinese economy is a much bigger driver of global growth today and we estimate the outbreak could reduce Chinese GDP by up to one percentage point in H1. However, although the recovery could be somewhat delayed, we still look for V-shaped rebound in global growth in Q2 once the outbreak is under control," says Aila Mihr, Senior Analyst at Danske Bank.

A v-shaped recovery suggests the Chinese and global economies will recover relatively rapidly once the outbreak is put under control and could explain why markets and emerging market currencies are moving higher.

Above: Markets are making an early bet that the coronavirus outbreak is starting to peak. Image courtesy of Johns Hopkins University Center For Systems Science and Engineering.

China's pre-eminent respiratory scientist Zhong Nanshan on Sunday said, "we believe the epidemic will peak in the next 10 to 14 days, but we still need to enhance preventive measures and not lower our guard."

Despite the beginnings of an attempted recovery in the Rand, Bishop says the coronavirus episode has had the effect of lowering the baseline in the Rand, which leaves it susceptible to triggering new multi-year lows if the looming budget and a potential Moody's downgrade occur in the first quarter.

"The Rand risks approaching, and exceeding, R16.00/USD this quarter if SA looks increasingly likely to see a Moody’s downgrade, given that the domestic currency has already reached a low base on the back of the impact from the 2019-nCoV on risky assets," says Bishop.

The Rand has underperformed its peers in the emerging market currency space during the coronavirus outbreak largely because of the sizeable domestic risks on the currency's horizon.

Markets are looking to the March 26 budget for signs that the Government is serious about maintaining fiscal discipline even as the economy stutters. The South African economy is under sustained pressure and economists say this will likely remain the case until President Cyril Ramaphosa introduces much needed reforms.

A budget that risks ballooning South Africa's debt pile could well trigger a downgrade in the rating of South Africa's sovereign bond status (the government borrows by issuing bonds). A downgrade would ultimately mean many global investors are unable to invest in South African debt, which would in turn potentially prompt capital outflows that pushes down the value of the Rand further.

Investec see a "lite down case" for the Rand - with a 38% probability - in which Moody’s downgrade South Africa's credit rating. However, the government does ultimately perform some repair work on the economy and the finances the prevents further substantial downgrades.

It also remains to be seen whether the fading in the market's anxiety over the Coronavirus outbreak is sustainable and any negative headlines could well spark a resumption in selling of global stock and emerging market currencies such as the Rand.

A "severe down case" with a relatively low probability of 15% attached would meanwhile "encapsulate the risk of severe external drivers to Rand weakness, and include the rapid spread of the 2019-nCoV worldwide, and a consequent, very severe negative impact on global economic activity," says Bishop.

Under a severe down case scenario the Pound-Rand exchange rate would rise to 21.00 by the end of the first quarter of 2020, 22.86 by the end of the second quarter, 24.07 by the end of the third quarter and 26.32 by the end of the year.

For the same periods, the U.S. Dollar-Rand exchange rate is forecast at 16.00, 17.50, 18.50 and 19.80.

The Euro-Rand is forecast at 17.76, 19.78, 21.18 and 22.77.

However, under Investec's base case scenario - at 39% probability - South Africa maintain their investment grade rating with Moody's while a severe global 'risk off' episode is avoided. Furthermore, market nerves over the expropriation of land without compensation are mitigated as the government takes an approach that sees abandoned, unused and government land given to new owners.

Under the base case scenario, the Pound-Rand exchange rate is forecast at 19.13 at the end of the first quarter of 2020, 19.33 at the end of the second quarter, 19.13 at the end of the third quarter and 19.21 at year-end.

For the same period, U.S. Dollar-Rand is forecast at 14.50, 14.80, 14.70 and 14.45. The Euro-Rand rate is forecast at 16.26, 16.72, 19.83 and 16.62.