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Emerging market economist Peter Attard Montalto of Nomura analyses the electricity, labour, balance of payments, fiscal and political issues that can affect the rand in the coming months.
OUR notional mid-year dollar-rand forecast target of 9.25 has already been met, prompting the question of where we go from here.
Our original view was that resurgent labour strikes and protest action, likely spilling into violence, would occur in the second quarter as a result of the wage round at that time, and also especially the mining sector reorganisation and retrenchments, which would begin and in turn prompt more labour unrest.
This is all still to come and hence our view of weakness from here is still intact.
What has happened first, though, is a series of strikes in the coal mining sector that have combined with outages of electricity supply to create acute load-shedding risks at this time.
On top of this, renewed issuance concerns after the Eskom tariff award and dual deficit and growth concerns have all fed into rand weakness. Up to now these factors have bubbled along, playing into the more fundamental concern about the underlying unsustainability of the dual deficit.
Below we look in more detail at whether these risks are still ongoing and whether they could drive the rand weaker still.
Strike action
We still see the mining sector restructuring through Q2 into Q3 (watch Amplats first), as well as the next wage round in the mining sector and more widely - including especially the municipal workers’ wage starting after Easter - as the key risk events.
With no turnaround in the levels of mistrust in traditional union structures and the increasing prevalence of violence, this could still be a market-moving story, especially if as last year it spills over to other sectors of the economy.
We see this as a two- to six-month story with high impact potential on the rand.
In the shorter term, on a two-month horizon with a medium impact potential on the rand, is the ongoing strike action at the Eskom build programme and the parallel strikes at a number of Exxaro Resources [JSE:EXX] and Anglo Platinum [JSE:AMS] mines, which are jeopardising coal supply.
This has already moved markets and its potential to continue to do so may wane.
Eskom
The electricity supply situation is extremely tight. We think the risk of load-shedding is the highest since start 2008.
Actually electricity demand is down some 4.1% since last year, yet the scale of maintenance and unplanned outages especially as a percent of peak demand is very high.
Indeed, the supply margin (the excess of production capacity and peak demand) is within the international safety margin of 5%.
A combination of import difficulties from Mozambique (broken transmission lines), half capacity at the nuclear reactor (generator out for unplanned maintenance), and now increasing coal supply issues means the system can easily be tripped over into load-shedding.
This could be even worse if combined with further unplanned maintenance (due to ageing infrastructure) and other factors like weather (which was what caused the 2008 crisis - there were problems with coal supply and then what coal there was got wet and couldn’t be used).
The system as a whole has around 40 days of coal use at the moment in reserve, but some of the strike-affected power stations have only around 18 days (within the 25-day safety limit). We therefore think the likelihood of load-shedding now is very high, albeit an ultimately unpredictable event.
The possibility of load-shedding in Q1 next year is also very high as the Medupi power station is now unlikely to be transmitting in Q4 of this year as originally planned and may only start in Q2 of next year, resulting in a 735 GW shortfall vs plans.
With the market only really pricing in Eskom risks since the end of February and given the 12.5% rally in USDZAR in Q1 2008 on load-shedding, then this would mean USDZAR could be as high as 9.95.
If we instead measure since the start of the year, then USDZAR at 9.52 is a more conservative estimate of the effect load-shedding could have on the currency.
Current account
While we expect the record -R24.5bn January trade balance to shed its one-offs and print back around -R11bn to -R14bn in February and March, the Q1 current account deficit would still be a hefty 7.1% to 7.3% of gross domestic product (GDP) when it comes out in three months’ time.
This is another reason why rand weakness may be seen in Q2. In the short term the market may overreact to the February trade number in two weeks, but investors should remember that a deficit over R10bn is still extremely large by historical standards.
Fiscal and issuance
We think high-frequency data may well have little direct impact on fiscal and, while we expect some underperformance, this year’s bad print of around -5.2% of GDP is already priced into the market after the recent budget.
As such, we think there may be more of a market reaction into the new fiscal year in Q2 when there is additional issuance in the domestic market and we see consolidation progressing more slowly than the budget might imply.
Additionally, the wider parastatal story in terms of government bailouts of South African Airways, Telkom restructuring, how Eskom, Transnet and the South African National Roads Agency deal with the erosion of the user-pay funding model will all be more pressing issues that may surface this quarter.
Overall, though, general fiscal worries should continue to combine with growth and balance of payment worries to be a key and ongoing market driver.
Ratings
Standard & Poor's reaffirmed its rating this week at BBB with a stable outlook which was no surprise given that it had two key hurdles for a downgrade – fiscal and labour unrest.
The first is seen not to have deteriorated enough and not had enough of an impact on competitiveness to be a tick yet, while the story on the latter had not changed enough since Q4 to warrant a move yet.
We think both of these will change by Q4 this year, with the additional unrest mentioned above and the tax commission being seen as a key drag on competitiveness. There should also be fiscal slippage by the time of the mini budget in October.
As such, we continue to expect a downgrade at the end of the year but think the ratings will not be a major factor yet.
Politics
There are few meaningful political events this year that we expect to be market moving.
The issue of politics is more general and includes the lack of implementation and acceptance of the National Development Plan (NDP) across general government, the lack of meaningful response on the mining sector after the Marikana troubles last year, and the general tone of debate in government on mining sector restructuring (i e taking away mining rights, etc).
One event to watch will be the Marikana Commission, which is already dragging on beyond the end of its four-month window. It may report sometime in Q3 and will likely be difficult for both the government and police.
More generally, we think the markets have priced out the positivity after the Mangaung elective conference, and no longer see Cyril Ramaphosa in such a positive light (presently at least, there is some hope for the future) given his lack of involvement in policy debates and in any of the current mining sector issues, despite his history in both ownership and unions in the sector.
The election campaign will not probably really heat up until into Q4, in our view, so should not be market-moving yet.
Intervention and rates
We think the reaction of the South African Reserve Bank (Sarb) to all this is rooted in a few axioms.
First, it is now much more open about rand fair value, as we have commented in the past. It sees it between 8.50 and 8.75, and admits it can overshoot strongly in both directions as part of its nature and that the bank should not necessarily do anything about that nature.
On top of that, the Sarb believes that the currency is giving a strong signal to government to speed up acceptance and implementation of the NDP, keep fiscal on the straight and narrow, and improve competitiveness, together with a signal of risk premia around Eskom and infrastructure and dual-deficit concerns.
As such we do not think, within reason, the Sarb wants to get in the way of what is happening. We do expect verbal intervention, partly reflecting the bank’s greater openness on fair value as opposed to increasing bullishness on intervention.
The stress scenario, however, is that in the event of a breakdown on the balance of payments (i e gapping prices much higher) the Sarb would ensure the integrity of the market.
Even under orderly markets, should the rand break up from 9.50 to 10.00, then there might be an increased possibility of reserve selling. However, until that happens we expect nothing.
Equally, we expect the bank to mention inflation concerns and even the need to react if they get out of hand, but we think the monetary policy committee would view currency-induced consumer price index increases as largely temporary and so (again under non-parabolic moves higher) would not hike rates.
After a period of short-run reflection, we think the market will likely recognise that the Sarb has a large cushion before it needs to react, and will hence be generally comfortable, when combined with additional risk shocks, about the rand moving higher still.
OUR notional mid-year dollar-rand forecast target of 9.25 has already been met, prompting the question of where we go from here.
Our original view was that resurgent labour strikes and protest action, likely spilling into violence, would occur in the second quarter as a result of the wage round at that time, and also especially the mining sector reorganisation and retrenchments, which would begin and in turn prompt more labour unrest.
This is all still to come and hence our view of weakness from here is still intact.
What has happened first, though, is a series of strikes in the coal mining sector that have combined with outages of electricity supply to create acute load-shedding risks at this time.
On top of this, renewed issuance concerns after the Eskom tariff award and dual deficit and growth concerns have all fed into rand weakness. Up to now these factors have bubbled along, playing into the more fundamental concern about the underlying unsustainability of the dual deficit.
Below we look in more detail at whether these risks are still ongoing and whether they could drive the rand weaker still.
Strike action
We still see the mining sector restructuring through Q2 into Q3 (watch Amplats first), as well as the next wage round in the mining sector and more widely - including especially the municipal workers’ wage starting after Easter - as the key risk events.
With no turnaround in the levels of mistrust in traditional union structures and the increasing prevalence of violence, this could still be a market-moving story, especially if as last year it spills over to other sectors of the economy.
We see this as a two- to six-month story with high impact potential on the rand.
In the shorter term, on a two-month horizon with a medium impact potential on the rand, is the ongoing strike action at the Eskom build programme and the parallel strikes at a number of Exxaro Resources [JSE:EXX] and Anglo Platinum [JSE:AMS] mines, which are jeopardising coal supply.
This has already moved markets and its potential to continue to do so may wane.
Eskom
The electricity supply situation is extremely tight. We think the risk of load-shedding is the highest since start 2008.
Actually electricity demand is down some 4.1% since last year, yet the scale of maintenance and unplanned outages especially as a percent of peak demand is very high.
Indeed, the supply margin (the excess of production capacity and peak demand) is within the international safety margin of 5%.
A combination of import difficulties from Mozambique (broken transmission lines), half capacity at the nuclear reactor (generator out for unplanned maintenance), and now increasing coal supply issues means the system can easily be tripped over into load-shedding.
This could be even worse if combined with further unplanned maintenance (due to ageing infrastructure) and other factors like weather (which was what caused the 2008 crisis - there were problems with coal supply and then what coal there was got wet and couldn’t be used).
The system as a whole has around 40 days of coal use at the moment in reserve, but some of the strike-affected power stations have only around 18 days (within the 25-day safety limit). We therefore think the likelihood of load-shedding now is very high, albeit an ultimately unpredictable event.
The possibility of load-shedding in Q1 next year is also very high as the Medupi power station is now unlikely to be transmitting in Q4 of this year as originally planned and may only start in Q2 of next year, resulting in a 735 GW shortfall vs plans.
With the market only really pricing in Eskom risks since the end of February and given the 12.5% rally in USDZAR in Q1 2008 on load-shedding, then this would mean USDZAR could be as high as 9.95.
If we instead measure since the start of the year, then USDZAR at 9.52 is a more conservative estimate of the effect load-shedding could have on the currency.
Current account
While we expect the record -R24.5bn January trade balance to shed its one-offs and print back around -R11bn to -R14bn in February and March, the Q1 current account deficit would still be a hefty 7.1% to 7.3% of gross domestic product (GDP) when it comes out in three months’ time.
This is another reason why rand weakness may be seen in Q2. In the short term the market may overreact to the February trade number in two weeks, but investors should remember that a deficit over R10bn is still extremely large by historical standards.
Fiscal and issuance
We think high-frequency data may well have little direct impact on fiscal and, while we expect some underperformance, this year’s bad print of around -5.2% of GDP is already priced into the market after the recent budget.
As such, we think there may be more of a market reaction into the new fiscal year in Q2 when there is additional issuance in the domestic market and we see consolidation progressing more slowly than the budget might imply.
Additionally, the wider parastatal story in terms of government bailouts of South African Airways, Telkom restructuring, how Eskom, Transnet and the South African National Roads Agency deal with the erosion of the user-pay funding model will all be more pressing issues that may surface this quarter.
Overall, though, general fiscal worries should continue to combine with growth and balance of payment worries to be a key and ongoing market driver.
Ratings
Standard & Poor's reaffirmed its rating this week at BBB with a stable outlook which was no surprise given that it had two key hurdles for a downgrade – fiscal and labour unrest.
The first is seen not to have deteriorated enough and not had enough of an impact on competitiveness to be a tick yet, while the story on the latter had not changed enough since Q4 to warrant a move yet.
We think both of these will change by Q4 this year, with the additional unrest mentioned above and the tax commission being seen as a key drag on competitiveness. There should also be fiscal slippage by the time of the mini budget in October.
As such, we continue to expect a downgrade at the end of the year but think the ratings will not be a major factor yet.
Politics
There are few meaningful political events this year that we expect to be market moving.
The issue of politics is more general and includes the lack of implementation and acceptance of the National Development Plan (NDP) across general government, the lack of meaningful response on the mining sector after the Marikana troubles last year, and the general tone of debate in government on mining sector restructuring (i e taking away mining rights, etc).
One event to watch will be the Marikana Commission, which is already dragging on beyond the end of its four-month window. It may report sometime in Q3 and will likely be difficult for both the government and police.
More generally, we think the markets have priced out the positivity after the Mangaung elective conference, and no longer see Cyril Ramaphosa in such a positive light (presently at least, there is some hope for the future) given his lack of involvement in policy debates and in any of the current mining sector issues, despite his history in both ownership and unions in the sector.
The election campaign will not probably really heat up until into Q4, in our view, so should not be market-moving yet.
Intervention and rates
We think the reaction of the South African Reserve Bank (Sarb) to all this is rooted in a few axioms.
First, it is now much more open about rand fair value, as we have commented in the past. It sees it between 8.50 and 8.75, and admits it can overshoot strongly in both directions as part of its nature and that the bank should not necessarily do anything about that nature.
On top of that, the Sarb believes that the currency is giving a strong signal to government to speed up acceptance and implementation of the NDP, keep fiscal on the straight and narrow, and improve competitiveness, together with a signal of risk premia around Eskom and infrastructure and dual-deficit concerns.
As such we do not think, within reason, the Sarb wants to get in the way of what is happening. We do expect verbal intervention, partly reflecting the bank’s greater openness on fair value as opposed to increasing bullishness on intervention.
The stress scenario, however, is that in the event of a breakdown on the balance of payments (i e gapping prices much higher) the Sarb would ensure the integrity of the market.
Even under orderly markets, should the rand break up from 9.50 to 10.00, then there might be an increased possibility of reserve selling. However, until that happens we expect nothing.
Equally, we expect the bank to mention inflation concerns and even the need to react if they get out of hand, but we think the monetary policy committee would view currency-induced consumer price index increases as largely temporary and so (again under non-parabolic moves higher) would not hike rates.
After a period of short-run reflection, we think the market will likely recognise that the Sarb has a large cushion before it needs to react, and will hence be generally comfortable, when combined with additional risk shocks, about the rand moving higher still.
