South African Rand: Looming Budget Poses a Risk to the 2021 Rally

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The brakes have been applied to the South African Rand's rally over recent hours, a development that will not surprise some market analysts and participants who are looking forward to next week's critical budget statement.

The 2021 budget will set the tone for the country's finances and send a critical signal of intent by the government to the investment community on how serious it is about reforming the economy.

Ahead of this key marker in the domestic calendar the Rand has nevertheless appreciated against the Pound, Dollar and Euro with February gains coming thanks to a stock market and commodity market rally that has seen emerging market currencies find favour.

The behaviour confirms the global backdrop remains supportive of the South African currency, even if the domestic picture is acting as a headwind.

Investor focus will fall squarely on the domestic element of the Rand's fundamental story on February 24 when Finance Minister Tito Mboweni delivers the national budget, where the country's poor business climate and the government's sluggish commitment to reform once again comes under scrutiny.

"The ZAR is potentially more exposed to some profit taking ahead of the presentation of the South African annual budget on 24 February," says Roberto Mialich, FX Strategist at UniCredit Bank.

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Some of this profit taking might already be on display: the Pound-to-Rand exchange rate has risen 0.75% back to 20.24 at the time of publication, following days of declines that saw the pair fall back towards the key 20.00 area.

The Euro-to-Rand is meanwhile 0.78% higher 17.65 while the Dollar-Rand rate is at 14.58.

How the Rand negotiates coming days will reflect how the contradictory forces of a supportive global backdrop and the unsupportive domestic scene resolve.

"The rand has seen a marked bout of strength over the past week as global financial markets' risk aversion levels have been eroded, and the rand remains highly sensitive to market movements given high risk status of its portfolio assets," says Annabel Bishop, an economist with Investec in Johannesburg.

Performance scorecards show ZAR is now the second best performing currency of 2021, with emerging market peer Turkey leading the pack confirming a growth in appetite amongst increasingly confident investors for 2020's laggards.

"While a lot of market exuberance is being built into investor appetite presently, the rand could strengthen somewhat further, but at some point the reality of domestic weak economic fundamentals will become a market consideration again," says Bishop.

Above image courtesy of Investec.

Elisabeth Andreae, a foreign exchange analyst with Commerzbank, says she sees only limited scope for appreciation in the Rand in 2021 owing to the fragile domestic economy.

"The mutated corona viruses and only slow progress in vaccination are jeopardising the economic recovery, as are persistent bottlenecks in the power supply. The medium- to longer-term outlook also remains subdued. Key factors are insufficient investment and a lack of structural reforms," says Andreae.

The analyst says South Africa's financial risks are set to come back into the focus of potential ZAR investors when the finance minister unveils his draft budget with updated projections.

"This is likely to weigh on the rand, especially as further rating downgrades are on the cards," says Andreae.

The country's fiscal position is precarious, with the government in October unveiling forecasts showing the consolidated budget deficit was on target to reach -15.7% in the current fiscal year.

The total deficit was expected to reach 81.8% of GDP, with the level rising to 95% in five years.

Mboweni said in June 2020 that unless South Africa's government implemented reforms the country was headed for a national debt crisis by 2024/2025.

Investors will therefore be on the lookout for signs of credibility in the government's attempts to close this deficit and avoid such a crisis, particularly when it comes to reducing the country's gargantuan public sector wage bill.

However, recent moves by the government to clean up corruption suggest an appetite for reform and Investec's Bishop says some of the Rand's gains over recent days might have a flavour of domestic optimism to them.

"Markets are cheering the clean-up of the state/parastatals, with hopes that this will persist into a second term with Ramaphosa," says Bishop, referencing recent news that the ANC's February NEC meeting has resolved to sideline party members who have been proven guilty of corruption.

In a potential sign of intent, President Cyril Ramaphose said on the weekend that unless the country brings its national debt down to sustainable levels, "no meaningful economic recovery will be possible".

A credible budget combined with a supportive global backdrop would result in something of a goldilocks scenario for ZAR bulls, an outcome which would likely see ZAR test fresh multi-month highs next week.

Regardless, Investec tell clients they expect the Rand will likely remain highly volatile in the foreseeable future.