Background
Over the past couple of months, the South African rand has suffered the same fate as most emerging market currencies, namely weakness resulting mainly from the imminent end of accommodating monetary policy in the US.
The currencies of most commodity exporters (excluding oil exporters) have been under pressure as a result of the slowdown of the Chinese economy and global concerns over the fourth wave of Covid-infections. A combination of higher bond yields in the US and uncertainty over new lockdown regulations has predictably led to a persistent risk-off sentiment amongst international fund managers.
November was a particularly good month for the US dollar, with virtually the full spectrum of highly tradeable currencies taking a beating against the world’s dominant currency. The currencies of India, China and Brazil were notable exceptions, but they have not been spared a pounding by the greenback since the beginning of the year.
From a medium-term perspective, it is important to note that the rand has not depreciated as much as several other key currencies, namely by less than 9.3% against the dollar between 1 January and 30 November. By comparison, two currencies that have a reputation for resilience, the Chilean peso and Polish zloty, have depreciated by 14.7% and 11%, respectively, over the past eleven months.
It is clear from the data in the table that the rand finds itself in decent company, with the heavyweight euro also taking a knock of more than 8% against the dollar since January. Risk appetites amongst global fund managers are likely to remain erratic and unpredictable, due to the prevalence of unparalleled uncertainty induced by the Covid pandemic. The uneven enforcement of lockdown regulations and travel bans around the globe has created a stop-start economic recovery and there is no clarity on the number of new waves of rising Covid infections via continued mutations of the virus.
This has led to unprecedented global supply chain disruption which, in turn, has caused significantly higher inflation in the US and several key emerging markets. Divergent opinions continue to exist amongst monetary policy makers over the nature and extent of higher inflation, with bouts of speculation over a return to a less accommodating policy stance fueling regular changes in the risk perceptions of fund managers.
Short-term prospects for the rand
An objective assessment of the rand’s value against the dollar and other key currencies requires a brief analysis of the major reasons for the recent weakness, as well as a reflection on the likelihood of any imminent changes to the factors that have weighed on the domestic currency.
1. A relatively over-valued position
As a starting point, it should be borne in mind that, since the onset of the Covid pandemic, the rand remains one of the best performing currencies in the world against the US dollar. As recently as the end of August, no other currency could match the 30% strengthening of the rand against the dollar since early April 2020. Although this has now been whittled away to an appreciation of 18%, only the Australian dollar had a better performance against the dollar between early April 2020 and the end of November 2021.
The contrasting short-term and medium-term performance of the rand begs the question as to whether scope exists for a larger measure of future stability or not. A factor weighing on the rand is related to the July unrest in parts of KwaZulu/Natal and Gauteng, which led to a sharp contraction of benchmark purchasing managers’ indices (PMIs), albeit temporary. It has become clear that the unrest was instigated by supporters of the country’s previous president who belong to the so-called radical economic transformation (RET) grouping, several of whom are facing corruption charges and were instrumental in attempts at state capture.
Despite the damage that the July unrest inflicted on the country’s international image as a stable free enterprise democracy and its ability to attract foreign direct investment, the recent trend of the long-term bond yield suggests that a healthy appetite still exists for portfolio investment in high-yielding and relatively risk-free domestic bonds.
2. The fickleness of global portfolio investment
A caveat to the prospect of a recovery of the exchange rate alluded to above is the unpredictability of global portfolio investment. According to Investec (quoting figures from Iress), foreigners were net sellers of South African bonds to the tune of more than R90 billion between September and November, whilst foreigners have also dumped domestic equities valued at R35 billion (net) during the past three months.
The estimated cumulative trade surplus of between R30 billion and R40 billion over the past three months was clearly insufficient to adequately counter these huge outflows. At least the rand was not the only currency to suffer from a temporary switch to dollar-denominated bonds and equities, with a number of other currencies also depreciating by more than 5% against the greenback in November, including the Turkish lira, Russian rouble, Mexican peso and Australian dollar.
The question is whether fund managers will soon develop a risk-on appetite again. When viewed against the exceptionally high spread that exists between emerging market bond yields and those of high-income countries, the answer is probably in the affirmative. Fund managers need to produce positive real rates of return to their clients and this has been extremely difficult in the face of negative nominal bond yields in a number of post-industrial economies.
Viewed from the perspective of global competitive indicators in the area of public finance and an improvement in the ratio of public debt to GDP, South Africa’s current yield on long-term bonds is decisively attractive, especially in an environment where global inflation starts receding again and future waves of Covid infections become more subdued and less fatal.
3. Commodity prices
South Africa’s trade surplus has taken a nosedive as a result of the important role of coal and iron ore in generating export earnings, the prices of which have declined by around 50% in recent months. This has halted the spectacular growth of the country’s trade surplus, although exports continue to exceed imports by a healthy margin.
According to World Data Lab, around 1.5 billion people, mainly in emerging markets, will join the ranks of the middle class over the next nine years. The relevant definition of “middle class” is a person who has between $100 and $1,000 to spend per day. Viewed from this perspective and against the background of the crucial future role in the switch to cleaner energy by the platinum group metals, it seems likely that the upward phase of the current commodity price super-cycle will continue well into the future. South Africa’s balance of payments should therefore remain strong over the next couple of years, suggesting an inevitable appreciation of the rand over the medium term.
Conclusion
The above analysis suggests that the rand’s current under-valuation against the dollar, estimated at 17.5%, is bound to be reduced as the world learns to live with the Covid virus and normality continues to return to the global economy. This view is reinforced by the prospects of improved corporate governance in the public sector at large and progress with government’s ambitious infrastructure program, currently valued at more than R800 billion.
Nedbank expects the rand to trade at around R15.45 against the US dollar towards the end of the year, with an average rate of R15.40 being forecast for 2022. This forecast seems entirely plausible, especially when viewed against the background of South Africa’s attractive bond yield and equally attractive dividend yields that can be earned on blue-chip companies on the JSE.
Any recovery of commodity prices, combined with progress with Covid vaccinations may, however, boost the rand further during 2022, with a return to the 2021 average rate of R14.80 also a possibility over the short-term to medium-term.