Amidst ongoing political and economic flux, investors are asking important questions as to the future of the Rand (and other emerging market currencies)…
In general, emerging market currencies, including the Rand, continue to be supported by the global search for better returns. However, SA risks are rising.
A Macro View
Encouragingly, global capital flows continue to support emerging markets. This is despite increased concerns about the economic fundamentals in many emerging markets, including South Africa. The major driver here is that markets such as South Africa continue to offer foreign investors relatively high returns (compared with investing in similar instruments in developed economies such as the USA.)
- For example, a foreign investor can potentially get a return of around 8.5% if they invest in a local 10-year government bond. A USA 10-year government bond offers a return of around 2%.
Consequently, foreign capital inflows have been supporting the Rand at a time when many South African investors have been looking to maintain a high exposure to foreign assets. This is on the back of concerns that the tumultuous politics in South Africa and the subsequent credit rating downgrades will lead to a much weaker Rand.
Where to now?
- At this stage, the foreign capital inflows out-weigh the domestic capital outflows.
- In addition, South Africa’s foreign trade account has moved from a trade deficit (imports exceeding exports) into a trade surplus. This is also bolstering the Rand.
Looking ahead to 2018, the risks associated with the Rand exchange rate could potentially intensify, depending on the outcome of the ANC elective conference in December 2017.
A vote by the ANC at the elective conference to essentially retain the current leadership into the 2019 National Election could lead to:
- further rise in populist economic and political policies
- continued weakening of investor confidence
- sustained low economic growth
- further credit rating downgrades
Under these uncertain circumstances, foreign investors might be unwilling to stomach the increased risk associated with SA, despite the favourable investment return differential – leading to significant currency weakness.
Alternatively, a decision by the ANC in December 2017 to move the political party in a different direction could strongly encourage further foreign capital inflows. This would include:
- a decision by the ANC to actively try and boost domestic household and business confidence
- recognition of the importance of regaining an investment-grade surge in foreign capital flows, coupled with South Africa’s on-going trade surplus could see the Rand strengthen further in early 2018.
In the short term (next 6 months): there is nothing to suggest that the current tendency for foreign capital flows to move towards emerging economies will change in any significant way.
Furthermore, SA’s credit ratings are likely to remain unchanged later this year as the rating agencies wait to see what key decisions are made by the ANC in December, as well as the progress made by the new Finance Minister in controlling the National Budget.
Importantly, depending on the outcome of these key events later this year and early in 2018, the Rand could prove to be extremely volatile as the market digests key economic and political developments…
Source: Alison Barker, ForexPeople Wealth / Kevin Lings, Chief Economist Stanlib