Strategists Stay Short South African Rand As Pressures Mount And Ratings Agencies Loom

Careful structuring of October's budget statement may help South Africa to avoid a ratings downgrade this year, but fiscal pressures and politics may threaten its investment grade status in 2018. 

Speculators should stay short the Rand, according to strategists at Bank of America Merrill Lynch, as mounting fiscal pressures are likely to mean South Africa loses its investment grade credit rating some time in the New Year.

Good progress to date in efforts to pare back government spending mean South Africa may avoid a downgrade by Standard & Poor’s in November. But the need to cut deeper amid already falling tax receipts may mean a downgrade becomes inevitable in 2018.

“The first rating downgrade on the local currency debt could happen as early as April-June of 2018 to be followed by a second downgrade that could push South Africa to below investment grade,” says Ferhan Salman, an economist at Bank of America Merrill Lynch.

While central government spending has been well contained in recent months, monthly government data has shown growth in South African tax receipts failing to match the rates necessary for the central government to hit its budget targets.

“We think rating agencies will wait for the political outcome of the ANC's National Conference in December; the 2018/19 budget measures; and growth realization for a change in the rating decision,” says Salman.

Careful structuring of the October 26 medium term budget statement may help South Africa to avoid a downgrade in November.

But political developments in December and a continued suboptimal performance on tax receipts will likely mean the government is unable to close the budget deficit by a sufficient enough measure to avoid action in 2018.

“The scenario of the Zuma camp prevailing at the end of the year implies a low growth environment. Coupled with slow fiscal deficit deterioration and higher nominal interest rates, this suggests an unsustainable debt-to-GDP profile,” says Salman.

Politics has been a source of pressure on South African assets in recent years as multiple allegations of corruption, not to mention an erratic style of government, swirled around the embattled president Jacob Zuma.

“We continue to think reformist hopes will be disappointed in the ANC's succession race. Final delegate numbers for the elective conference in December are still marginally skewed to the Zuma camp,” says Salman.

December’s ANC party conference is the next milestone in the story of South African politics, where members will choose either a continuation of the status quo by electing the incumbent’s former wife as party leader, or a reformist leadership under the banner of Deputy President Cyril Ramaphosa.

“As the fiscal and the political story turn negative in 4Q18, South African assets are likely to weaken. We stay short ZAR,” says Salman. “We have a marketweight view on sovereign credit and are underweight equities.”

The Pound-to-Rand rate was quoted 0.42% lower, at 17.82, Thursday. It is up by more than 5% for the year to date. 

The Dollar-to-Rand was quoted 0.21% lower at 13.48 Thursday and has fallen by 1.67% during the year to date.