Analysts Divided Over Outlook for South African Rand as Global Factors and Land Reforms Loom Large

- ZAR to recover some lost ground say Treasury One.

- Economic recovery, reforms, to drive ZAR lower say Investec Bank. 

- But Commerzbank say US Dollar strength and ZAR losses to continue.

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ZAR could be close to bottoming out after months of heavy selling by international investors, according to one analyst, although others still expect more losses to come and are flagging the government's land reform agenda as a significant risk to the currency.

South Africa's currency was among the world's best performers during the three months to the end of March 2018, rising 10% against the Pound and Dollar as markets cheered a regime change at the top of South African politics that many hope will bring the country an economic renaissance. 

However, Tuesday saw the currency nursing 10% losses against both major currencies for the year-to-date after three months of heavy selling. But while some of these losses are the result of domestic factors, most have been caused by events in the offshore environment and some now say the currency is close to its nadir. 

"Reasons given for this unprecedented move range from the US trade wars, selling off in emerging markets, portfolio outflows and local wage issues. While all of them are valid, looking at the constant SA fundamentals, we believe that the Rand is caught up in the international noise and should start to recoup some of its losses as the dust begins to settle," says Andre Botha, a senior currency dealer at TreasuryOne, a South African international payments firm.

A resurgent US Dollar has been the single greatest driver behind the South African sell off in recent months as it has dented the Rand which has in turn seen international investors dump other South African assets by the bucket load.

Data from the Johannesburg Stock Exchange shows outflows of capital from South Africa reached record highs this year as international investors dumped South African government bonds and moved money overseas. Botha says this sell-off will soon come to an end.

But Commerzbank Eye a Stronger Dollar, Weaker Rand 

"The change in government under the leadership of Ramaphosa had led to exaggerated hopes for a political and economic recovery, that have since been partially corrected. More recently US President Trump’s protectionist trade politics have fuelled concerns about a global trade war thus causing a flight into safe currency havens, which caused many EM currencies to further depreciate in June," says Elisabeth Andreae, an analyst at Commerzbank.

Andreae says President Trump's trade war and a resurgent Dollar have got the market focused on current account deficit countries, with those that have large deficits being penalised the most. South Africa is a prime candidate for targeting by speculators given the government runs a budget deficit of around 4% of GDP which, not only larger than the nation's trade surplus, must be funded by domestic and international borrowing. 

Often it is international markets that countries like South Africa turn to for funding, with loans frequently denominated in foreign currencies, which means debt servicing becomes more expensive during times when the US Dollar is rising and the Rand is falling. If taken to extremes, routs in emerging markets can sometimes see countries struggle to secure new funding from international lenders, which heaps further pressure onto their economies. 

Analysts at the world's second largest ratings agency, Moody's, explained in a briefing this week the dangers posed to emerging market economies by the current environment. 

"Countries with large current account deficits, high external debt repayments and substantial foreign-currency government debt are most exposed to the impact of a stronger US dollar," writes Alastair Wilson, Moody's global managing director of the Sovereign Risk Group. "To the extent that these currency fluctuations reflect capital outflows or significantly lower external inflows, they are credit negative for sovereigns with large external funding needs."

Andreae and the Commerzbank team forecast the US Dollar, which has converted a 4% 2018 loss into a 2.6% gain during the months since the middle of April, will continue to rise for a while yet and so they also expect the Rand depreciation to go on. The Rand does after all have a strong negative correlation with the US greenback.

They predict the USD/ZAR rate will rise to 14.25 before year-end and to remain there through much of 2019. The Pound-to-Rand rate is seen rising to 18.83 before the current year is out. 

"The economy depends on capital imports. This is reflected in the high current account deficit and in the high number of rand denominated government bonds held by foreigners," Andreae writes, in a recent briefing, before flagging political risk as an emerging but important issue for the currency. 

Investec Forecast a Stronger Rand, but Warn of Risks

South Africans had high hopes of President Cyril Ramaphosa, who will face an election in May 2019, when he came to power in February. Not only do many expect his prescription of reforms to political and economic governance to lift growth from its current depressed levels, some are also banking on Ramaphosa implementing a programme of "land reform" that could see the state sieze private property without compensation. 

For a country that is as dependent as South Africa is on being able to attract foreign investment to fill the government budget deficit, a government programme of "expropriation without compensation" risks sending the wrong signal about South Africa to international markets.

Economists at South Africa's Investec Bank have say the market impact of the reforms will depend on a range of factors, including whether siezed land is awarded to individuals rather than the state and if expropriations can be implemented in an orderly manner.

Wide scale land grabs would risk disrupting commercial use of the land and could hit the economy, while leaving many land "owners" without title deeds. The question of whether the reforms target "certain groups" may also be important.  

Investec say their base case, which is assigned a 45% probability, is for an orderly reform of land ownership to commence this year and for economic recovery to push the USD/ZAR rate back down to 12.70 in 2018 and 12.25 before the end of 2019. 

However, they also warn there is a 35% probability the economy disappoints and efforts at an orderly land reform go awry, leading USD/ZAR to 15.90 in 2018 and a record low of 19.60 by the end of 2019. 

The USD/ZAR rate was quoted 1.04% lower at 13.69 Tuesday while the Pound-to-Rand rate was 0.73% lower at 18.03.

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