Rand Volatility to Pick Up as South African Establishment Approach Pivotal Moment - 5% Swing Possible

Change is imperative if South Africa is to avoid losing its last investment grade credit rating but the ANC's weekend leadership election is too close to call. 

The Rand has enjoyed broad stability in recent days although strategists are warning of volatility ahead as South Africa’s ruling ANC party prepares to elect a new leader at its annual conference this weekend.

ANC’s conference will elect the party’s next president as well as its candidate for the state presidency in the 2019 general election. The race is seen as being between the reformist deputy President Cyril Ramaphosa and the incumbent president Jacob Zuma’s ex-wife Nkosazana Dlamini-Zuma.

It is a pivotal moment for the currency and broader economy, with financial markets looking for signs that change is afoot in South African politics.

The outcome could have considerable influence over whether or not Moody’s, the last to have an investment grade rating assigned to South African local currency sovereign debt, holds off on a downgrade in the New Year.

“Overall, we think risk-reward is still asymmetric. The rand is down 5% in real terms vs. summer, and bonds are more than 400bp wide to inflation and trade at levels that reflect BB- rating in local. So we think pricing still reflects higher chances of a Zuma victory and we remain constructive on SA assets,” says Ferhan Salman, a strategist at Bank of America Merrill Lynch.

Above: Pound-to-Rand rate shown at daily intervals.

Bank of America strategists suggest the market is pricing a near-status-quo outcome from the weekend’s conference and so bets on a victory for the reformist Ramaphosa should effectively be cheap and lower risk than bets on a renewed sell off in South African assets. But not everybody agrees.

“Rand trade might be boring now but it is expected to be explosive over the weekend. One-week implied volatility on USD/ZAR has jumped to over 30% (30-36 bid/offer on Reuters this morning), implying the market now puts over a 50% probability of a 5% move in the rand over the week, i.e. to under 13.00 or over 14.30,” says John Cairns, a currency strategist at Rand Merchant Bank.

South Africa’s local currency sovereign debt rating was downgraded by Standard & Poor’s in November, to beneath the investment grade level, leaving the country and its economy at the mercy of Moody’s next rating decision.

S&P cited concerns over the combined effect of a rising budget deficit and headwinds facing the economy - which have slowed the pace of GDP growth and hit tax receipts.

Alleged corruption within the government and governance within state owned enterprises, whose debts are guaranteed by the South African state, is also an issue.

“Discussions around possible scenarios have dominated our meetings in South Africa, but less than a week to the ANC Elective Conference, there is still great uncertainty as to who has the best odds of winning the presidency of the party,” says Christian Maggio, a strategist at TD Securities.

Political change is seen as imperative if South Africa is to avoid losing its last remaining investment grade credit rating, from Moody’s, which would have significant consequences for the economy.

“Since mid-November financial markets have seemed to us to increasingly expect Cyril Ramaphosa to win the December 16-20 election for the new leader of the ANC,” says Sonja Keller, an emerging market strategist at JPMorgan.

Above: USD/ZAR rate shown at daily intervals.

Loss of Moody’s investment grade rating would mean South Africa’s ejection from the Citi World Government Bond index and the automatic exclusion of its debt from all investment grade and index-tracking credit funds.

This would raise the cost of borrowing, exacerbate the budget deficit and make it more difficult for South Africa to raise finance in future.

“However, we view the political outcome as considerably less certain and find that recent branch nominations point to at most a narrow advantage or, perhaps more likely, no outright win for either the modernist Ramaphosa or Dlamini-Zuma,” adds Keller.

Keller and the JPMorgan team say the reformist Ramaphosa has at best, based upon branch nominations, a 51.3% chance of winning the leadership vote at the weekend. Dlamini-Zuma has a 43.5% chance of clinching the nomination.

There is also some prospect of delegates at the conference eschewing both the good and the bad, in favour of a proverbially-ugly "unity candidate" who can bring both the traditionalist and modernist wings of the party together.

This might not be enough to save South Africa's credit rating although, as it stands, a decision from Moody's is seen coming only in the first-quarter of 2018 after the next budget plan is unveilled by the Treasury. 

The Pound-to-South-African-Rand rate was quoted 0.27% higher at 18.20 shortly after noon in London Tuesday. The USD/ZAR rate was marked 0.24% higher at 13.62.

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