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Azar Jammine: Why Rand is surging, #StateCaptureReport only half the story

South Africa is even noisier than usual this morning. And with Thuli Madonsela’s report putting evidence of State Capture into the public domain, there is much to chatter about.

Trust the cool headed Azar Jammine to put the financial repercussions into perspective. In this insightful assessment, the chief economist at Econometrix explains why these major developments in the political economy have had such a dramatic impact on the country’s “share price”.

After taking a hit when trumped-up charges were thrown at Finance Minister Pravin Gordhan, the Rand has risen strongly as the forces of darkness were turned back. Over the past five months, it is the best performing currency on earth – a period that correlates well with the turning of the tide.

It’s hard to think that the Gupta brothers, who did a midnight flit in April, were sufficiently emboldened weeks later to return for another run at State Capture. That now looks like just one more dumb decision by the boys from Saharanpur. – Alec Hogg  

By Azar Jammine*

The South African political environment has been extremely active over the past week, with fraud charges against the Minister of Finance and other former SARS officials being withdrawn.

This development has been followed by judicial denials of the interdicts by President Zuma and Corporate Governance and Constitutional Affairs Minister Des Van Rooyen to prohibit the publication of the previous Public Protector’s report on “state capture”.

The report has subsequently been released, reinforcing most of the concerns regarding the state capture by leading South African politicians, including the president.

Not coincidentally, these developments have been accompanied by a significant appreciation in the Rand’s exchange rate against all currencies, especially the US Dollar. The Rand stands head and shoulders above all other currencies in terms of its performance over the past fortnight as well as over the past five months.

The implication of the latest judicial developments has been to reinforce the power of South Africa’s judiciary and more generally its institutions.

It has also diminished chances of a so-called “capture” of the National Treasury and the public purse by forces closely connected to President Zuma who has been seen to be eyeing control of Treasury as a means of gaining access to lucrative deals with public corporations and institutions.

In turn, the perceived enhancement of the strength of the judiciary as an institution and the reduction in chances of a loss of control over fiscal discipline by the Treasury have been interpreted as enhancing chances of South Africa’s still being able to avoid a credit rating downgrade later in the month.

Some will even go so far as to suggest that recent developments have increased chances of President Zuma being compelled to resign from his post.

Pressures on him to do so have undoubtedly increased in recent times. Perceptions are that in the event of Zuma vacating the presidency, there would be an immediate uplift to business confidence in the country’s economy and its outlook which would be positive for the currency and for its chances of avoiding a credit rating downgrade.

However, US factors also generating strength in rand/dollar exchange rate

Whilst most of the attention seems to be focused on the effects of domestic political developments on the Rand, sight may have been lost of the fact that part of the appreciation of the Rand/Dollar exchange rate in the past few days has been global in nature.

This coincidence of currency movements being influenced simultaneously by both domestic and international factors perpetuates a phenomenon witnessed over the past two years. Some of the Rand’s strength is attributable to recent Dollar weakness. The Dollar has depreciated from $1.08 to the Euro a fortnight ago, to $1.11 most recently.

This can be attributed in large measure to the increased probability of Donald Trump after all managing to win the US presidential election.

The FBI’s investigation into private e-mails sent by competing presidential candidate Hillary Clinton according to opinion polls has increased the potential support for Trump vis-a-vis Clinton, notwithstanding the lewd comments relating to the former issued a fortnight ago. Markets are particularly concerned that a Trump presidency will be harmful for the US economy, ushering in a period of protectionism.

Indirectly, the possibility that this in turn will generate a recession in the US economy has been interpreted to imply that US interest rates may be forced to stay lower for longer under a Trump presidency.

Trump_Clinton_caricature

As a result, funds would stand to continue flowing out of the Dollar into higher yielding emerging market currency deposits and bonds. As a frequently used proxy for risk appetite (or risk aversion) for emerging markets, this has contributed towards greater strength in the Rand than any other emerging market currency.

In contrast, given that Trump has stated that he wants to build a wall across the border between Mexico and the US, the gains in his chances of ascending to the presidency of the US have caused the Mexican Peso to weaken perceptibly.

There should be caution against undue optimism over the rand

One would, however, like to caution against undue optimism regarding prospects for South Africa avoiding a credit rating downgrade and its currency maintaining recent strength. There can be no doubt that even at current elevated levels, the Rand is still quite cheap on a purchasing power parity basis.

However, the chances of a credit rating downgrade are still quite high. The possibility of the departure of Zuma and confidence in South Africa’s institutions is not going to nullify the structural impediments preventing South Africa’s economic growth rate from rising to more attractive levels necessary to prevent the rising trend of unemployment from continuing.

market_exchange_rates_compared

An inability to raise the sustainable growth rate of the economy still leaves the probability of generating faster growth in government revenue needed to reduce budget deficits, quite low. Such deficit reduction is in turn necessary to limit the rise in the public debt and in so doing help appease ratings agencies.

One must bear in mind that steep tax increases are on the horizon for next year’s Budget. This is likely to put the lid on any strong recovery in economic growth.

Given that these are critical factors being examined by ratings agencies, there remains a substantial probability of ratings been downgraded after all. Besides, there is absolutely no certainty that Zuma will leave the presidency before the termination of his term of office in 2019.

Also read: In the gutter: Trump vs Clinton. Who will win? Expert analysis

Concerns are likely to resurface that his successor as president of the ANC, to be decided at the party’s presidential election conference at the end of next year, will also be subjected to “state capture” in the same way as Zuma is perceived to have been.

Furthermore, for the present, despite the fact that many within the ANC would like to see Zuma go, the majority of the National Executive Council (NEC), in whose ambit the process of recalling the president’s falls, remain Zuma supporters.

Little by little some of these might be abandoning such support, but until such time as a majority within the NEC become convinced that Zuma has to go, the country is likely to retain him as president. The judicial process of bringing him to book on charges of state capture and corruption has also got some way to go and Zuma is an expert at ensuring his own survival with the assistance of legal process as a delaying tactic.

Currency approaching a cyclical low point

From a technical point of view, the Rand is likely to meet resistance at levels between R13.20 and R13.40 where the currency last faltered a month ago. It is interesting to see how the currency has tended to weaken from such levels for whatever reason.

Besides this, we have identified a 30-week cycle from low point to low point in the Dollar (high point in the Rand). The last such cyclical low point was in April, which means the trend is likely to reach a low point very soon.

There are two possible potential factors that could bring about a reversal in the Rand’s positive fortunes. Firstly, Hillary Clinton is still likely to be voted in as the US’s next president.

The increased business confidence that this might bring about stands to be accompanied by renewed expectations of higher US interest rates, causing funds to flow back out of emerging markets and into the Dollar.

Alternatively, the Rand could weaken later in the month in the wake of a credit rating downgrade. Even though much of the chance of a downgrade has already been discounted in the present exchange rate, were such a fact to finally be confirmed, it is likely that the currency would experience some sell-off. For these reasons, it is prudent at present to cover forward fairly heavily on import contracts.

  • Dr Azar Jammine is the chief economist at Econometrix
* For more in-depth business news, visit biznews.com or simply sign up for the daily newsletter.

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