South African Rand Forecasts Slashed by ABSA as Offshore and Domestic Risks Mount

- ZAR forecasts downgraded by S.A's third largest lender, ABSA.

- Strong USD to weigh further on ZAR as domestic risks stack up.

- USD/ZAR to rise 6% before year-end, GBP/ZAR to rise by 8%.

Image © Richard Atkinson, reproduced under CC licensing

The Rand will weaken further than was previously expected this year, according to the latest forecasts from analysts at ABSA, who argue that offshore and domestic challenges will weigh on the South African currency during the months ahead.

South Africa's Rand is already down 6.7% against the Dollar and more than 5% against the Pound for 2018 but, given it had risen by a similar measure during the first-quarter, it has actually fallen by an even greater degree since the middle of April.

"We have become significantly more bearish about the exchange rate in recent months," says Peter Worthington, a senior economist at ABSA, Africa's third largest bank by assets. "The stronger USD environment and growing threat of global ‘trade war’ are fuelling global risk aversion, which in turn is causing large capital outflows from emerging markets such as South Africa."

Worthington and the ABSA team previously forecast the Rand would recover some of its losses before year-end but this call has begun to look more and more doubtful in recent weeks.

International investors have sold some ZAR61 billion of South African government bonds during 2018 and more than ZAR4 billion of stocks as fears over the stability of the economy have escalated.

Above: USD/ZAR rate shown at daily intervals.

The USD/ZAR rate was quoted 0.64% lower at 13.17 Monday while the Pound-to-Rand rate was 0.16% lower at 17.50.

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

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Strong USD Looms over Rand

Unease across financial markets over President Trump's "trade war", as well as a US economy that is going from strength to strength, has seen American bond yields rise and the Dollar emerge resurgent from the depths of a bear market this year.

This has been bad for the Rand because 45% of South African government debt is owed to foreigners, with much of it denominated in US Dollars, which means those debts are now more expensive for the fiscally challenged South African government to service.

Other emerging market central banks, such as those in Turkey and Brazil, have already raised their interest rates in a bid to stem capital outflows and stabilise their currencies. However, the South African Reserve Bank (SARB) has remained impervious to market pressures so far.

"We also believe that the market has become too hawkish about policy rate expectations, which implies that the ZAR could weaken from an interest rate differential perspective if these rate hike fears subside," says Worthington.

The SARB is widely expected to hold South Africa's main interest rate at 6.5% Thursday but economists will be looking for assurances the central bank will act if the currency encounters further the months ahead. Any failure to deliver this assurance could give way to even further losses for the Rand.

South Africa is a prime target for speculators in a "risk off" environment, which often sees emerging market currencies dumped in favour of safe-havens like the US Dollar and Japanese Yen, given the government runs a budget deficit of around 4% of GDP.

This deficit must be funded by domestic and international borrowing. However, if taken to extremes, routs in emerging market currencies and bonds can sometimes see countries struggle to secure new funding from international lenders, which heaps further pressure onto their economies.

Risk and Reforms in Focus

"After President Ramaphosa secured a wafer-thin victory at the ANC’s December elective conference in December, progress in governance was in many ways surprisingly swift and robust once he finally managed force his predecessor, Jacob Zuma, to resign in mid-February," says Worthington. "However, new leadership is only the first step to rehabilitating the state. And some important political issues remain unresolved."

Higher interest rates from the SARB may be able to prop up the Rand in the short term but the currency's long term prospects will depend on President Cyril Ramaphosa being able to implement a series of political and economic reforms. However, the jury is still out on whether he will be able to do so.

After sweeping to power in February and rapidly reshaping the management board of state owned utility Eskom, momentum behind Ramaphosa's reform agenda has ebbed, with the government now bogged down in debates over controversial, but populist, reforms to the system of land ownership less than a year out from a general election.

Opposition politicians have forced the beginning of a constitutional reform process geared at facilitating a policy of land expropriation without compensation, designed to reduce inequality of ownership and set right perceived historic injustices.

The policy risks raising questions about South Africa's commitment to private property rights and stoking the ire of the market. Already, South Africa's economy contracted sharply during the first-quarter but it can only shrink so much further before the budget deficit, which is measured as a portion of the GDP or the economy, becomes inflated.

This would draw the scrutiny of ratings agencies that until recently, held the threat of a rating downgrade above the head of South Africa like a Damocles's sword. A loss of South Africa's local currency investment grade rating would accelerate capital outflows from the country and place further pressure on the Rand.

Forecast Targets

It is these domestic and offshore challenges that both the SARB and South African political leadership must balance during the months ahead. ABSA forecasts that these challenges will see the Rand weaken further before it eventually stabilises.

They now predict the USD/ZAR rate will finish the year at 13.75 before the end of September and that it will hit 14.0 by year-end, which implies a further 6% fall from Monday's 13.20 level.

The Pound-to-Rand rate is expected to rise to 18.49 by the end of September and 18.90 before year-end giving an ~8% potential upside as at the time of writing GBP/ZAR is quoted at 17.50.

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