Credit Suisse: South African reforms can strengthen rand in long term

By David Whitehouse
Posted on Thursday, 28 April 2022 06:00

South African Rands
South African Rands REUTERS/Philimon Bulawayo

South Africa has a rare chance to use investment inflows and improved terms of trade as a basis for reform which can produce a stronger rand in the long term, Credit Suisse director Alexey Pogorelov tells The Africa Report.

Rand outperformance versus other emerging market currencies earlier this year was driven by the increase in global commodity prices, which helped to offset higher energy prices, Pogorelov says in London. South Africa exports commodities including platinum, iron ore and coal.

Alongside a sizeable current account surplus, the economy has also benefited from strong portfolio inflows into the equity market, partly due to relocation from other financial markets such as Russia which are no longer available, he says. The result is that the rand “has become more resilient to the tightening in the global financial conditions thanks to a stronger external position.”

The rand started the year at 15.8 to the dollar, and strengthened to 14.2 in late March. It has now weakened back to around the original level of Jan 1. Pogorelov notes that there are still worries over the Chinese economy which may negatively impact demand for raw commodities imported from South Africa. In the longer run, he says, the outlook for the rand depends on the success of reforms that the government presented in its medium-term budget policy statement (MTBPS) and the 2022 budget.

Finance Minister Enoch Godongwana in his February budget proposed reducing the rate of corporate income tax by one point to 27% from March 2023. The budget included promises of reform to rationalise state-owned enterprises (SOEs), improve port efficiency and allow private operator access to freight rail lines. Godongwana’s budget was generally well received by business, but sceptics pointed to a lack of specifics on SOE reform.

  • Currently, the high unemployment rate, elevated debt and structural shortfalls, for example in energy generation, limit South African economic growth, and hence the potential for the rand to strengthen, Pogorelov says.
  • The country’s currently improved terms of trade mean that the government now has a “unique opportunity” to invest in “more sustainable economic growth that without a doubt will transform into a stronger rand,” he adds.

US Fed

The carry trade, in which financial institutions borrow in low-yielding currencies with the aim of earning higher yields abroad, is one factor which influences the rand’s level. The difficulty for the rand as a carry-trade currency is that the US dollar/rand pair is widely seen as a proxy for emerging market risk in general, and sees speculative flows as a result, says Omar El-Gazzar, foreign exchange dealer at Crown Agents Bank in London.

The rally in commodity prices since the Russian invasion of Ukraine is “a positive headwind” given the make-up of South Africa’s exports,” says Gazzar. But “that may not be enough to temper the negative outlook.”

  • The effect of the US Federal Reserve policy on the rand can’t be overstated, and the Fed’s shift to a more aggressive than expected tightening policy has highlighted the “underlying fragility” of South Africa’s currency, Gazzar says.

Still, the rand may have some advantages over alternative emerging-market currencies in Asia, says Lars Sparresø Merklin, senior FX strategy analyst at Danske Bank in Copenhagen.

  • Asian currencies seem to be more negatively affected by rising import prices as they are generally all importers, he says, adding that prospects for a weaker Chinese renminbi are also likely to affect other Asian currencies versus the dollar.

Bottom line

Improved terms of trade provide what may be a rare window of opportunity for South African reforms which would make the rand a less speculative currency.

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