The rand is paying the price for SA economic, political woes

The rand is paying the price for South Africa’s woes, with the 20 per dollar level now firmly in sight as investors fret about restrictive monetary policy adding to a deepening power crisis and political missteps to throttle the already ailing economy.

The currency plunged to a record 19.84 per dollar on Thursday after the South African Reserve Bank raised its policy rate to a two-decade high. That capped six straight weeks of losses for the rand in the face of unprecedented electricity shortages and a diplomatic row with the US over South Africa’s ties with Russia. Options pricing shows an 80% chance that it will hit 20 within the next month.

The central bank said its restrictive policy stance was necessary to curb inflation, even as it warned that more rand weakness was likely. But the move will add strain to an economy that’s forecast to grow by just 0.3% this year. Falling commodity prices and a slowdown in China — South Africa’s biggest trading partner — are also weighing on output and prompting investors to exit the country’s stock and bond markets.

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“The health of the local economy is now the primary concern,” said Brendan McKenna, an emerging-markets strategist at Wells Fargo Securities in New York. “It’s difficult to make a really compelling case to deploy capital toward South Africa and the rand at the moment.”

‘Tipping point’

The rand pared some of its decline on Friday, rising about 1% against the dollar. But options pricing suggests more losses are in store. One-month risk reversals – the premium investors pay for options to sell the currency over those to buy it – climbed on Friday to the highest level since the start of the pandemic.

The central bank’s hiking cycle will only turn when the price-growth trajectory changes and inflation starts moving toward 4.5%, Governor Lesetja Kganyago said. He placed much of the blame for rising prices at the door of government, which bears responsibility for high administered and regulated prices including electricity and water. Money markets are pricing in another 75 basis points of rate hikes by year-end, with the first policy relief only arriving in May next year.

“While higher interest rates usually act to protect the value of the rand, there comes a tipping point where the effect of higher rates on GDP growth starts to impact the currency negatively,” said Kim Silberman, an economist at FirstRand Bank Ltd., which expects the rand to remain under pressure even as the Federal Reserve starts easing policy and the dollar weakens.

Allegations by the US earlier this month that South Africa supplied arms to Russia sent the rand tumbling more than 5% in four days, while the premium investors demand to hold the country’s dollar bonds rather than US Treasuries widened about 30 basis points. South Africa is hosting the BRICs Summit in August, with Russian President Vladimir Putin on the invitee list — another political risk event that may trip up the rand.

Read: Ramaphosa rules out SA abandoning neutral stance on war in Ukraine

‘More sensitivity’

“Markets may be assigning more sensitivity to any news given the recent geopolitical situation over South Africa’s stance regarding Russia and preferences for foreign policy non-alignment,” said Erik Meyersson, chief emerging-markets strategist at SEB AB in Stockholm.

The central bank said rolling power cuts — referred to locally as load shedding — would cut 2 percentage points off GDP growth this year as the struggling state-owned electricity company, Eskom battles breakdowns at generation units. Plans to alleviate the utility’s debt burden and introduce more renewable energy into the grid are moving at a glacial pace.

Slowing growth would worsen South Africa’s fiscal outlook, with tax revenue falling short of expectations. That would complicate the government’s efforts to consolidate debt and bring down its fiscal deficit.

“The culmination of negative developments means South Africa could likely be staring at negative, not only flat, growth this year,” justifying an underweight position in the rand, Citigroup Inc. strategists.

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