Many commentators have turned very bullish on the rand as they extrapolate current strength into the future. What are the bullish case/factors?
- A weaker dollar.
The enormity of the quantitative easing is starting to weigh on the value of the dollar. Combine that with a much smaller yield advantage post their recent rate cuts and the dollar has lost its shine. The dollar index (DXY) has lost 3% for 2020 to date, but is down 10% from its peak in March. With post-election stimulus very likely, the pressure on the dollar is set to remain.
- Ample global liquidity.
All global central banks have added liquidity and reduced interest rates. Low rates combined with high liquidity, forces risk capital into the corners of the earth looking for returns.
- The rand’s attractive carry.
S.A. has some of the highest bond yields and real rates in the world. With little pressure on inflation currently the 6% real rate on 10Y bonds seem very attractive to yield-hungry global investors. Unfortunately you have to divide that juicy rate by the volatility of the rand to get the sharp ratio of the carry and that removes all but the most gutsy yield-seekers.
- An improvement in the current account balance.
The current account deficit has in fact flipped to a small surplus. Yeah…that’s great for the rand! Is it? The balance didn’t improve due to increased exports, but due to an implosion of imports. The S.A. consumer is tapped out and so imports of all those luxuries have all but vanished. The ‘improvement’ in the current account balance is thus for the wrong reason and short-lived. The infrastructure program announced by the president will import large quantities of capital goods, so look for a current account deficit again in 2021.
- Bullish bets on EM in general.
Many global fund managers feel that the U.S. is fully priced and that Emerging Markets and Europe offer better opportunities (VALUE) once growth returns to normal. EM has thus experienced positive flows the last few months. The return to normality is still a long way away.
- International loans
S.A. received emergency funding from several global institutions. These loans are medium term in nature and denominated in hard currency. In order to apply these funds in S.A. it needs to run through the FX market. These flows have strengthened the rand materially recently, but this is temporary and non-fundamental. This apparent ‘strength’ has propelled the rand to the best performing E.M. currency this month. That is insanity considering the sobering facts of the MTBPS, but has none-the-less inspired many extrapolations.
Then there’s the other side of the coin or the bearish factors:
- Deteriorating fiscal metrics.
S.A. fiscal numbers were bad pre-Covid…they are abysmal post-Covid. Mr. Mboweni is forgiven for the horrid numbers, because the entire globe is in this crisis together. Unfortunately S.A.’s growth decline is double that of the EM peer group and our subsequent recovery half the EM average. With debt servicing cost the fastest growing and also the largest single item in the budget, it’s just a matter of time before we face a debt crisis.
- Sovereign debt crisis developing.
Debt to GDP ratios in excess of 100% is now common cause for China, Japan, U.S.A. and most of Europe, including the U.K. but is a nightmare for emerging countries as they battle to attract funding. S.A. went through 60% debt/GDP this year, and will reach the horrible 100% milestone by 2023. S.A. is the country with the fastest and largest increase in debt/GDP ratio in the world over the next few years. Government is doing a ‘head-in-the-sand’ by describing an ‘Active’ and ‘Passive’ scenario. They claim to be on the active/best-case scenario, but a lack of political will/mandate will deliver an end-result much closer to the passive/worst-case scenario. Zambia should be a stark warning of what lies ahead.
- Smaller foreign appetite for S.A. bonds
Foreigners have sold R70bn of SA government bonds this year. Their total holding of SA bonds has declined to less than 30% for the 1st time in a decade. The proportion of trade on a daily basis has also declined to record lows, indicating a lack of interest and international liquidity.
- Large hard currency emergency loans
S.A. has taken on $5.3bn of medium term loans from international agencies for Covid-relief. These funds are used for short term emergency supplies and even for government employee salaries. You’re now financing domestic running expenditure with medium term loans in hard currency. Once repayments of these start, it will force existing resources to service loans that didn’t add to long term capacity.
Do not get fooled by the short term ‘strength’ in the rand. It is due to synthetic flows and short term phenomena. There is no long term fundamental factor that points to significant rand strength from here onwards. Instead we’re barreling headlong towards a fully-fledged sovereign debt crisis that promises to send the rand to new record levels against hard currencies in the years ahead.
Source: George Herman. Director and Chief Investment Officer | Citadel.