Close to a year has passed since the rand tested new record lows in the wake of the Lady R debacle. With general elections just around the corner and markets widely expecting the US Fed to start cutting interest rates later this year, now is an opportune time to take stock of the rand’s direction.
The rand’s performance has been choppy since US Ambassador Reuben Brigety accused the South African government of supplying munitions to Russia in May last year. In recent days the currency has again kicked up to around R19.20/$ in response to the increase in geopolitical tensions in the Middle East. It does, however, remain better than the R19.90/$ level it breached nearly a year ago.
But what can we expect going forward? To plot out the plausible scenarios, we can look at the rand’s historical performance; tools such as fair value models; the global macroeconomic climate; and South Africa-specific political and economic risk factors. Let’s look at each of these in turn:
The rand’s historical performance
Over the past five decades, the rand has declined in value against the US dollar in most years. When we zoom out and consider the rand’s performance versus the US dollar over the past 12 years, it has depreciated in value at an average rate of around 7.5% a year. But the rand doesn’t depreciate at a consistent annual rate.
Instead, it tends to drop sharply below fair value in response to local political shocks like Lady R and Nenegate or global earthquakes like 9/11 and COVID-19. Once markets are calmer, the rand tends to grind back towards fair value or even stronger – before falling again. There is no reason to think that this long-term pattern will change any time soon.
Fair value
One of the most important tools in our belt for assessing the rand’s potential direction is our fair value model. We use a Currency Decoder from our research partner, Analytics Consulting, which calculates the level at which the rand should be trading by benchmarking it against the dollar relative to where the dollar itself is trading against its trade-weighted peers. The model also takes into account how emerging market currencies in general are trading against the dollar.
The model currently indicates that the rand’s fair value is around R18.28 to the US dollar and that, at today’s exchange rate of R19.20/$, the rand is currently trading at a discount of around 5%. Given the fact that the rand tends to more often trade at a discount than a premium to fair value, the current differential is relatively close to the long-term average.
In a risk-on environment, the rand tends to outperform its emerging market peers because of its high levels of liquidity. The opposite is true in a more risk-averse landscape. Again, we see no reason why these patterns should change. But it’s worth noting that South Africa’s junk sovereign debt status and greylisting may mean it will command higher risk premiums for its currency, equities, and bonds than it did 10 years ago.
This, combined with the risk of the blow-outs noted above, would suggest that there is probably more risk of rand weakness than there is of significant rand strength over the remainder of the year.
Global macroeconomics
The global macroeconomic climate – more specifically, the relative strength or weakness of the dollar versus other currencies – is the single largest factor determining the direction of the rand. External research indicates that as much as 70% of the rand’s movements is determined by the dollar’s direction of travel.
As the global safe-haven currency, the dollar has shown remarkable strength in the face of geopolitical events of the last five years and emerging market currencies have come under pressure. With US inflation reads coming in slightly hotter than expected and the economy still performing strongly, many commentators have tempered their expectations around how soon and how many times the Fed will cut interest rates this year.
However, should the Fed indeed decide to cut interest rates in the coming months, it could create a risk-on environment that would reverse some of the dollar’s gains and lift the rand along with other emerging market currencies and assets. We see this as one of the only factors that could lead to rand strength of any significance. However, if the Fed cuts interest rates at a slower pace, the rand can be expected to keep trading within the current band in the absence of other global or local risk factors.
South Africa-specific risks
The final consideration is South African-specific political risks, economic policy, and macroeconomic conditions. For the South African rand to strengthen significantly and sustainably, we would need to see dramatic improvements in local economic and fiscal performance in the years to come.
South Africa doesn’t have a good story to tell in this regard. Public finances are in a precarious state, with the country’s debt-to-GDP ratio expected to have climbed from 24% in 2008 to peak at 75.3% in 2025/26, with very few positive applications of these increased borrowings! This figure may be optimistic, arguably failing to provide for the full debt burden and turnaround costs of the country’s state-owned enterprises.
GDP growth is not even close to the numbers needed to keep up with an expanding population. Pervasive lawlessness and corruption, infrastructural challenges including Eskom load shedding, a deteriorating water system, and transport logjams, combined with an abysmal public service from all spheres of government, bode ill for the future.
Far from introducing market-friendly reform and reshaping the public sector to address these challenges, the ruling party is doubling down on economically destructive policies and laws – including cadre deployment, prescribed assets, the Employment Equity Amendment Act, and the National Health Insurance (NHI) Bill.
We cannot foresee an election outcome that changes this picture meaningfully for the better in the short term, thereby creating a more positive domestic environment for the rand. It is true that the ANC faces the prospect of slipping below 50% of the vote at the national level, especially in provinces such as Kwa-Zulu Natal and Gauteng.
But if the base case scenario is a 45-50% poll, the ANC will need to form coalition governments with smaller parties that are closest to its ideological leanings. As we’ve seen in several municipalities, such arrangements may beget instability and deepen institutional corruption rather than fostering better governance.
The worst case scenario would be a lower poll in the order of, say, 37%, resulting in an alliance with populists such as the Economic Freedom Fighters (EFF) and the recently-formed MK party that leads to an even more pronounced drift to socialism. (This scenario is not, in our view, priced into the rand at present!) But even if the ANC partners with the “Moonshot Pact” – an unlikely outcome – there is no capacity and little willingness in the public sector to change its work outputs and culture, which by necessity requires a “top-down” approach.
The bottom line
The current convergence of local and international factors, along with our fair value models and what we have learned from history, suggests that it remains prudent to take advantage of any temporary periods of rand strength to externalise funds. This isn’t just about the value of the rand, however.
It’s also about the superior investment opportunity set offshore. World markets have consistently outperformed South Africa even without the benefit of currency depreciation. Given South Africa’s present trajectory, we expect this to remain the case in the longer-term future.
Hi Ryan,
Thank you for this , always impressed by the insights from ynasty.