Rand's Zexit Rally Could be Nearing its End

© GCIS, Government of South Africa

Zuma's resignation is significant but much still rests on whether the Treasury can use next Wednesday’s budget statement to set out a credible plan for bringing down South Africa’s budget deficit.

South Africa’s Rand surged ahead against its international rivals during early trading in London Thursday, extending its overnight gains, as markets cheered the resignation of South Africa’s embattled President, Jacob Zuma.

However, with the Rand already up by double digit numbers in the last three months and a long road to economic reform lying ahead, analysts are sceptical about how much further South Africa's currency can go.

After nine scandal plagued years as President, South Africa’s Zuma resigned late on Wednesday, bringing the ANC and opposition’s month-long effort to remove him to a close.

South Africa's rand jumps to highest against dollar since 2015 after Jacob Zuma resigns https://t.co/IRCq66MSt9 pic.twitter.com/b1DGIsreaj

— Bloomberg (@business) February 15, 2018

“I have come to the decision to resign as President of the Republic with immediate effect. Even though I disagree with the decision of the Leadership of my organization, I have always been a disciplined member of the ANC,” then-President Zuma said, in an address to the nation Wednesday.

“As I leave I will continue to serve the people of South Africa as well as the ANC, the organization I have served all my life. I will dedicate all of my energy to work towards the attainment of the policies of our organization, in particular the Radical Economic Transformation agenda.”

Wednesday’s resignation is significant for South Africa because, under new leadership, it is hoped that the government can begin to repair the public finances and reform its political as well as economic governance. 

Markets have been betting a change of leadership would enable South Africa to avoid a downgrade of its local currency debt rating, by Moody's, in March.

“This decision provides certainty to the people of South Africa at a time when the economic and social challenges facing the country require urgent and resolute response by all sections of society,” Jessie Duarte, deputy secretary general of the ruling ANC party, said in response to the resignation.

“The ANC now expects all our deployed members of parliament to cast their vote for the ANC President, Comrade Cyril Ramaphosa, as the candidate the ANC will nominate for President...It is critical that South Africans are now united around the task of growth, job creation and economic transformation.”

Above: USD/ZAR rate shown at daily intervals. Captures price action from ANC leadership election to date.

The USD/ZAR rate fell 0.70% to 11.63 during early trading in London while the Pound-to-Rand rate slid 0.41% to 16.34.

Both exchange rates are down by nearly 4% in the last week and have fallen close to 20% in the last three months.

Most of these gains have come since the election of Cyril Ramaphosa as president of the ANC party and Jacob Zuma’s eventual replacement, back in December.

“Our take over the past week has been that a resignation would trigger some knee-jerk rand gains but that these would not continue for very long,” says John Cairns, a currency economist at Rand Merchant Bank.

"We maintain this view. As such, our best guess at this stage is that the knee-jerk might continue into this morning, but will ultimately fade."

Above: Pound-to-Rand rate shown at daily intervals. Captures price action from ANC leadership election to date.

"Assuming Ramaphosa is confirmed as the new President by Parliament, there are several events to watch going forward," says Adam Cole, head of FX strategy at RBC Capital Markets.

"(1) the 2018 Budget announcement on February 21, which we expect to drive ZAR’s risk premium higher, (2) a cabinet reshuffle, including the potential replacement of FinMin Gigaba, and (3) the Mining Charter Review (February 19-21), which we expect will yield some positive developments but not enough to offset the downside risks from the Budget.”

For South Africa, much still rests on whether the Treasury can use next Wednesday’s budget statement to set out a credible plan for bringing down South Africa’s budget deficit.

After all, Moody’s, the international ratings agency, has held the threat of a sovereign downgrade to "junk" over South Africa’s head like a damocles sword ever since it put the country “on review for downgrade” back in November.

Structural economic reforms, as well as improved governance of state owned enterprises, are key to whether Moody’s will hold off on a downgrade to South Africa’s local currency debt rating at its next review.

A loss of investment grade status could be devastating as it would see many institutional investors forced into selling their government bonds. This would push South African borrowing costs higher and put downward pressure on the Rand once again as foreign investors flee the country.

“Now Zuma’s successor will have to deliver and confirm the hopes the market has placed in him, something that will be difficult in view of the weak fundamental framework conditions,” says Esther Reichelt, an analyst at Commerzbank.

Reichelt flags low economic growth, high unemployment and South Africa’s ageing infrastructure as problems that need to be fixed and reasons to think Ramaphosa’s early days in office will be far from easy.

These challenges are amplified by the fact that, with a budget deficit that is in excess of 4% of GDP and drawing scrutiny from ratings agencies, Ramaphosa’s room for manoeuvre in terms of spending is low.

“We do not believe that Ramaphosa will be able to simply pull solutions to these challenges from a hat like a rabbit and therefore assume that ZAR will depreciate initially,” Reichelt adds.

“The South African central bank’s credible monetary policy will however support ZAR slightly and will prevent it from crashing.”

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