Published: February 19th, 2021
Despite a strong start to the week that saw the South African rand (ZAR) strengthen against both the dollar and the euro, markets had hit the brakes by mid-week, as wary investors looked for safety in advance of next week's critical budget statement.
Forex markets are treating Pretoria's 2021 budget as a critical signal of intent about how serious the government is about reforming the country’s up-and-down finances.
Rand has appreciated against the dollar, euro, and pound in the lead-up to this vital fixture on South Africa’s economic calendar. ZAR has also benefitted from an equities and commodity market rally that’s lifted emerging market currencies across the board this month.
That would seem to confirm that the global backdrop for rand is positive, even if domestic politics start to pull it back to Earth.
Markets will be laser-focused on the fiat's domestic fundamentals' next week when the finance ministry delivers the national budget on 24 February. South Africa’s overall business climate has been challenged by pandemic, and Pretoria’s level of commitment to liberal economic reforms is about to face added investor scrutiny.
FX Strategists at UniCredit Bank told investors this week that ZAR may be exposed to profit-taking ahead of the budget’s formal release.
It could be happening already. Sterling-to-rand rose by three quarters back to 20.23 at mid-week, following days of declines that saw the pair drift down to the critical 20.00 level.
How the Rand fares over the coming days will reflect how the competing dynamics of a supportive global backdrop and a challenging domestic situation find a route to resolution.
Economists at Cape Town-based Investec said in an investor note that rand’s strength over the past week could be partly attributed to reduced risk-aversion in global financial markets.
Crunching the numbers, they said their performance charts show ZAR is now in second place for year-to-date 2021 amongst top-performing emerging market currencies. Only the Turkish lira (TRY) has delivered higher yields.
Investec also said that market enthusiasm is affecting investor appetite, an effect that could push the rand further up against competitors. What hasn’t been apparent up to this week is at what point the cold realities of weak economic fundamentals in South Africa will move to the front and centre.
At Commerzbank, foreign exchange analysts told Bloomberg they see minimal scope for further rand appreciation this year because of the tenuous national economy.
With the recent emergence of a 'South African' strain of COVID-19 and a slow vaccination rollout, the prospects for a fast economic recovery may be dimming. Power supply bottlenecks in the country's national grid are also a severe concern for business growth. What investors will want to see I next week’s budget are infrastructure investment mixed with structural reforms.
Potential ZAR investors will closely watch South Africa's financial risks when the finance minister unveils his draft budget with fresh growth projections.
South Africa’s fiscal situation is precarious, with government forecasts showing a consolidated budget deficit of -15.6 per cent in this fiscal year.
Alarm bells started ringing at the major global lenders when the total deficit was forecast to hit nearly 82 per cent of GDP, a level that could rise to 95 per cent in five years.
In June, the finance minister announced that significant reforms would be needed to lift the country’s finances and avoid a national debt crisis in 2024. Forex traders and investors will watch for signs that the government is taking serious steps to close the budget gap and get its books in order.
Politically, that won’t be easy. The country's public sector wage bill is amongst the highest amongst emerging market economies.
Recent moves to clean up corruption point to an appetite for change, and some of Rand's recent gains could be a sign that markets believe the government is in earnest about its debt reduction promises.
South African President Cyril Ramaphosa said last week that the country would need to wrestle the national debt down to sustainable levels; otherwise, a meaningful economic recovery won't be possible.
Suppose Pretoria tables a credible budget and the global economic environment remains supportive. In that case, ZAR bulls could well see a goldilocks scenario emerge, with rand testing new multi-month highs in the budget announcement aftermath.
For the moment, however, the outlook is in flux. Most analysts and currency strategists are advising clients to expect rand to be highly volatile in the coming days and weeks.
ZAR began the week by reaching its strongest level against the greenback and came close to touching a key marker against the euro. Rand’s rise was driven by sunny global investor sentiment that supported interest in South African assets.
Rand demand rose as global markets sustained the risk-on approach that’s made for a bullish February. Traders have been on the lookout for high-yield assets on the back of demand uptick for commodities, typically a signal that resource-reliant emerging markets will benefit.
Currency strategists at CBA told investors this week that expected US fiscal support, the ongoing vaccine rollout, and a loose hand on the global monetary tiller all point to reflation in the rand.
Post-pandemic recovery is expected to kick up a notch this year, which should leave South Africa's economy on a comeback footing. FX analysts at Commerzbank said that South Africa appears to have soldiered through the COVID-19 second wave, and global markets have responded with indications of confidence — buying up ZAR and rand-backed assets.
Rand is expected to find additional support when institutional investors start pouring money into South African corporate and government debt.