South African Rand Edges Higher with Chinese Yuan but Nearing Budget Could Put Brake on Advance

-ZAR rises with China’s CNH after falling to open the week.
-May be constrained ahead by budget & U.S. election jitters.
-SA credit rating, surplus commitment in focus in Oct budget.

Image © Government of South Africa, reproduced under CC licensing

• GBP/ZAR spot rate at time of writing: 21.44
• Bank transfer rate (indicative guide): 20.69-20.84
• FX specialist providers (indicative guide): 21.12-21.25
• More information on FX specialist rates here

The Rand advanced Tuesday even as the U.S. Dollar clawed back earlier losses from many of its rivals, with the South African currency edging higher alongside the Chinese Yuan, although gains may be increasingly difficult to sustain ahead of October's medium-term budget statement. 

South Africa’s Rand was higher against the Dollar and Pound as well as most major developed and emerging market rivals as the Yuan appeared to steady.

China's currency was blindsided on Monday by domestic regulation changes that made it easier for international investors to bet against it. 

“The ZAR continues to perform surprisingly well. This looks largely down to the Chinese recovery, where South Africa, as a metals exporter, stands to benefit. Over the last twelve months and apart from the SGD (which is formally managed against the Renminbi) the ZAR has the highest EMFX correlation with the CNY,” says Muhammet Mercan, a strategist at ING. “Watch out for the medium-term budget later this month. Debt sustainability is a ZAR negative and could come back to haunt.”

Regulators scrapped a rule requiring banks to set aside capital when dealing in Yuan forward contracts, making Yuan ‘short’ positions less cumbersome for local lenders to facilitate, after a months-long rally took the Chinese currency back to highs not seen since mid-2018.  

The Rand has been a relative outperformer this last week and sits in the middle of the rankings for the recent month, although it’s rebounding from record lows against the Dollar and a multi-year trough relative to Sterling while still remaining an underperformer for 2020 overall. 

“USD/ZAR has recently been rejected by the April-to-September resistance line, now at 17.0804, but so far remains side-lined above the September low at 16.0838. Failure there on a daily chart closing basis would lead to the September 2018 high at 15.6945 being targeted,” says Axel Rudolph, a senior analyst at Commerzbank. “Resistance still comes in between the 200- and 55- day moving averages at 16.7908/9060 and at the September high at 17.2718.”

Above: USD/ZAR rate shown at hourly intervals alongside USD/CNH (black line, left axis).

Tuesday’s gains built despite a widespread rebound by the U.S. Dollar, which advanced against almost all major currencies with analysts citing a disclosure by Johnson & Johnson suggesting its coronavirus vaccine could face delays after an unforeseen problem in phase three clinical trials. 

The Dollar has been sold heavily in recent months which, along with strength in the Yuan, has provided breathing space to emerging market currencies. But with the November 03 U.S. presidential election now just weeks away the danger is that investor caution leads the Rand and other risk currencies to run aground. 

Many analysts say range-trading is likely to define U.S. Dollar exchange rates in the final weeks of October, with caution dominating in a period that will also see Finance Minister Tito Mboweni provide the next update on South Africa’s finances to parliament and the country. 

Above: South African Treasury supplementary budget projections. 

“The credit rating agencies have warned of further downgrades for South Africa, with Moody’s highlighting that SA is likely in line to sink deeper into sub-investment grade, from its current equivalent BB+ rating, as government finances continue to deteriorate. We continue to expect a downgrade post MTBPS, from Ba1 (BB+ equivalent) to Ba2 (BB equivalent). National Treasury still has not finalised the MTBPS date, but reporting continues to centre round the 21st October,” says Annabel Bishop, chief economist at Investec. “Both Moody’s and S&P are scheduled to deliver their country reviews on 20th November, with the MTBPS projections informing their ratings decisions on SA, and Fitch also likely to deliver a verdict around that period.” 

The national budget deficit is expected to top 15% of GDP in 2020, according to June’s supplementary budget, when it had been expected to fall to around -5.9% before the coronavirus closed down the global economy in March.

South Africa had already seen its last remaining ‘investment grade’ credit rating cut to ‘junk’ and even before the virus struck, economists had feared the country would slide further into sub-investment grade territory. 

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

“Troubling fiscal dynamics, anemic growth and current account deterioration are set to weigh on the rand in our view,” says Saad Siddiqui, a strategist at J.P. Morgan, who sees USD/ZAR at 17.0 by year-end. “While near-term deficit funding is broadly on track, over the longer term we expect South Africa will face substantial problems in financing the large fiscal deficit. This could possibly trigger periodic bouts of stress in the bond market and capital outflows.”

With the debt-to-GDP ratio most recently forecast by the Treasury to rise to 87.4% by 2024, that slide down the rating scale could come quicker than many had envisaged.

It’s not clear when October’s medium-term budget will be but the market will be sure to scrutinise it closely in any case, especially after Finance Minister Mboweni pledged in June to deliver a primary surplus by 2023/24. 

The prospect of a further deterioration in Treasury forecasts, or backtracking on the commitment to a primary budget surplus, could constrain the Rand in the weeks ahead in instances where pre-election caution and Dollar moves don’t. This is given that it could accelerate the decline in South Africa’s credit rating, which would make South African government debt less attractive to investors, raise financing costs for the country and could also weigh on the Rand. 

“SA is at material risk of further downgrades from all the credit rating agencies,” says Bishop, who tips USD/ZAR for a 2020 finish at 16.50. “South Africa faces even higher borrowing costs, and is reaping the outcome of the Zuma years of mismanagement, governance  failures and huge deterioration of government finances from the healthy state achieved during the Mbeki administration. The long slow burn through SA’s fiscal strength via corruption, inefficiencies and wastages, poor fiscal choices and destruction of structures and technocracies, has caused the country to face a fiscal cliff and increased chance of default.”