Pound-Rand Knocking on 20.00's Door as South Africa Slips into Recession

Image © Comugnero Silvana, Adobe Stock

- GDP data shows a surprise fall in growth in Q2

- Data triggers another sell-off in the Rand

- GBP/ZAR continues its uptrend higher and touches 19.50

The South African Rand weakened notably on Tuesday, August 04 after GDP figures showed the country falling into a technical recession.

Second quarter GDP fell -0.7% compared to the first quarter in which a -2.2% fall was recorded, the brace of negative readings mean the economy has entered a technical recession.

The result was well below the 0.6% forecast by markets; cue selling of the Rand.

The weakness was driven by a fall in activity across a wide range of sectors.

At the time of this article's update the Pound-Rand exchange is up 2.26% at 19.54 and the prospects of an extension of the rally towards the R20.00 barrier have increased substantially.

The data means South Africa meets the criteria for a recession which is two consecutive quarters of negative growth. The last time the economy was in a recession was in 2008-09 during the great financial crisis when it experienced three quarters of negative growth.

The main reason for negative growth in Q2 was a "fall-off in activity in the agriculture, transport, trade, government and manufacturing industries," say Stats SA.

Headline data has been heavily dragged down by a fall in private consumption (down to -1.4% Q/Q annualised from +1.0 in Q1) and deceleration in public expenditure (down to +0.7% from +1.4%).

"This latter factor is the likely result of the government trying to reign in the budget deficit," says a response by TD Securities to the data.

Agriculture production fell by 29.2% in the second quarter of 2018, following a 33.6% slump in the first quarter.

Stats SA say was largely driven by a decline in the production of field crops and horticultural products.

Continued drought conditions in Western Cape and a severe hailstorm in Mpumalanga, resulting in extensive crop damage, also placed additional pressure on production in the second quarter.

Industry sectors which saw growth included mining, construction, electricity, finance and personal services.

Mining’s growth rate of 4.9% was largely spurred on by a rise in the production of platinum group metals, copper and nickel.

Construction activity increased by 2.3%, driven by a rise in non-residential buildings and construction work activities.

"The economy is operating against a backdrop of mounting supply driven inflationary pressures and relatively subdued activity. Furthermore, a low GDP growth remains a sovereign credit rating weakness and this together with the ongoing populist direction of some of SA’s actual and proposed economic policies continue to damage investor sentiment and therefore economic growth," says Lara Hodes at Investec.

Investec warn heightened external risks remain, including the possibility of further financial market stress, escalating trade protectionism and heightened geopolitical tensions, leaving South Africa's economy vulnerable to further weakness going forward.

The SA Rand was already finds itself in a strong downtrend versus most counterparts as a result of emerging market contagion caused by the crisis in the Lira and escalating trade war fears.

The strengthening Dollar has increased many SA borrower's repayments heaping pressure on SA debt markets.

The direction of travel of the economy now means the government cannot afford to waste time in implementing market-friendly policies, while it would also do well to jettison those populist policies that diminish the view of South Africa as an attractive investment destination amongst international investors. 

"Overall, the 'Ramaphosa revolution' is still struggling to become visible, but it has always been the case that economic improvements will take much longer to become tangible than the market is ready to wait for. The ZAR is now under renewed pressure and may find it difficult to reverse without an external backstop, i.e. improving risk sentiment," warn TD Securities.

TD Securities suggest market pressure may force the government to swiftly enact economic reforms and rethink plans to go ahead with the land expropriation without compensation plan.

"ZAR weakness will also increase the odds of a SARB hike going forward, as the ZAR debacle becomes worrisome for the stability of the CPI outlook," say analysts at the global investment bank.

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