International Commentary — July 14, 2021
South Africa's Turning Point?
Summary
Once the top performing emerging market currency of 2021, the South African rand has reversed course. The recent fall in the currency can be attributed to another wave of COVID infections and subsequent lockdowns, while politically charged protests related to the imprisonment of former president Jacob Zuma are dampening sentiment toward the rand. Over the course of this year, we suggested the currency's outperformance was unwarranted and maintained our view for a weaker currency over the medium-to-longer term as South Africa's economic fundamentals remained weak and relatively fragile. As political demonstrations take place, we believe market participants will nally take notice of underwhelming fundamentals and place pressure on the currency. In addition, we believe the South African Reserve Bank will keep rates on hold through the end of the year, which can also contribute to a weaker rand going forward.
Economist(s) Brendan McKenna
Rand Reversals
Through the end of June, the South African rand was one of the top performing emerging market currencies of the year. A general improvement in sentiment toward emerging market currencies, along with progress on reform agenda items, supported the rand to levels not seen since early 2019. Throughout the rand's appreciation trend, we consistently noted how we felt the strength of the currency was unwarranted. Despite reforms being made, we felt South Africa's debt trajectory was still concerning, contingent liabilities tied to Eskom and other state-owned assets were prevalent, all while the economy struggled to gather momentum amid waves of COVID infections and a sluggish vaccination campaign.
Over the last week, the reversal we have been waiting for materialized. Another wave of COVID infections and new restrictions has certainly contributed to a weaker rand; however, politically-charged protests in response to the imprisonment of former president Jacob Zuma has also played a signicant role in the rand weakening. While we did not assume nationwide demonstrations would be the catalyst for a weaker currency, we do, however, believe political dynamics could be the spark that forces market participants to pay attention to South Africa's underwhelming economic fundamentals, especially as the broad market euphoria toward emerging market currencies begins to fade and country specic developments have a larger inuence over the path of EM currencies.
For the most part, demonstrations have taken place in KwaZulu-Natal and Gauteng, the main economic hub where Johannesburg is located. Manufacturing plants as well as Sapref, the country's largest oil renery, have been forced to close, while small businesses and shops were also shuttered. Food and other essential items are in shortage as highways and other transport routes have been shut as well. In addition, vaccination eorts across the country have also been disrupted, which could result in COVID-related restrictions being in place for longer than originally intended, further delaying the already slow economic recovery.
For now, we do not believe the social unrest will last much longer and will not bake a further increase in political risk into our USD/ZAR exchange rate forecast. In fact, reports today suggest eorts to suppress violent protests have been successful and demonstrations are beginning to calm, and the currency has recovered some losses. However, the South African economy could come under additional pressure as a result of protests, and the likely economic disruptions will act as further rationale to maintain our bearish view on the rand going forward.
Central Bank Tightening O The Table
A third, and more severe, wave of COVID infections is currently underway in South Africa. As mentioned, vaccination eorts have been slow, which has relegated South African policymakers to implement lockdowns and impose restrictions on heavily infected areas. As the third wave of infections gathered pace in June, harsh restrictions were reimposed, taking Oxford University's Stringency Index sharply higher (Figure 1). New restrictions will disrupt economic activity, while the protest-related disruptions highlighted above should have an economic impact as well. South Africa's economic recovery has been a notable laggard, even within the emerging markets. So much so, that the South African Reserve Bank (SARB) has delayed tightening monetary policy even as peer central banks have lifted policy rates. To that point, in its May Monetary Policy Committee statement, SARB noted the likelihood of two 25 basis point rate hikes this year, one in Q2 and another in Q4. Given elevated infections and slow economic recovery, SARB chose not to raise its repurchase rate in Q2, even as CPI ination trends toward the upper end of its ination target range.
Given the current state of the economy, we believe nancial markets are mis-pricing policy rates in South Africa, which in our view, should also contribute to a weaker currency. As of now, nancial markets are priced for policy rates to be 3.88%, implying 63 basis points of tightening over the next three months (Figure 2). We believe rates are likely to be left on hold at least through the end of Q3, and as of now, through the end of the year. SARB will meet to assess monetary policy next Thursday, where we believe it will adjust expectations for interest rate increases. We expect South African policymakers to communicate the local economic recovery is uneven and uncertain, and as a result, monetary policy will need to be as accommodative as possible. In addition, we feel policymakers will focus its statement on rising ination, but ultimately suggest price growth is temporary. Transitory ination dynamics should also keep interest rates on hold. As interest rate hikes get priced out of nancial markets, the rand should come under pressure and continue to depreciate through the end of this year and likely into 2022.
Figure 1 0 25 50 75 100 0 25 50 75 100
Jan-2020 May-2020 Sep-2020 Jan-2021 May-2021
South Africa Stringency Index
100 = Most Stringent ; 0 = Least Stringent
Source: Bloomberg LP and Wells Fargo Securities
Figure 2 3.00% 4.00% 5.00% 6.00% 7.00% 3.00% 4.00% 5.00% 6.00% 7.00%
Jan-2020 Jul-2020 Jan-2021 Jul-2021
South Africa Implied Policy Rate
3-Month Ahead Implied Policy Rate
Implied Policy Rate: Jul-14 @ 3.88% Repurchase Rate: Jul-14 @ 3.25%
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Jay H. Bryson, Ph.D. Chief Economist (704) 410-3274 jay.bryson@wellsfargo.com
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