Publications
Partners
The volatile rand has confounded South Africans once again, rallying by 3.5% to R13.67 against the dollar the day after a dreaded credit rating downgrade which took it one step closer to exiting a prestigious global bond index – an event expected to trigger huge capital outflows.
The currency’s reaction was all the more remarkable given the relentless barrage of bad news over the past few months about the economy, the state of government finances and mounting political uncertainty ahead of the ANC’s leadership conference in the middle of December.
Even those who had predicted the rand would waver less than anticipated after a decision by Standard & Poor’s to relegate the country’s local currency credit rating to junk status were taken aback by the extent of its appreciation.
Moody’s Investors Service held off when the two ratings agencies announced their decisions on 24 November, but put its local and foreign currency ratings for South Africa – which it still has at investment grade – on review for a downgrade after the Treasury publishes its February budget. (Also see the cover story on page 22.)
That decision would strip SA of the remaining criteria for staying in Citigroup’s World Government Bond Index (WGBI), forcing passive fund investors to sell their holdings of rand-denominated government bonds and triggering a potential outflow of $10bn.
There are a couple of fairly obvious explanations for the rand’s rally. One is that the bad news was already “priced in” to financial markets, while another is the growing conviction that Cyril Ramaphosa, the ANC’s most business-friendly leadership candidate, would beat rival Nkosazana Dlamini Zuma at the elective conference.
Bond investors were also encouraged by reports immediately after the rating decisions that president Jacob Zuma had instructed finance minister Malusi Gigaba to keep debt from spiralling out of control by finding ways to raise another R15bn in tax revenues and cutting spending by a further R31bn.
The Treasury also announced that plans to improve access to higher education would be implemented in a phased and sustainable manner, dispelling earlier reports that Zuma planned to announce an unaffordable R40bn package for free university education.
But there are other, more fundamental reasons why the rand rallied and why it may hold on to the bulk of its gains – and possibly add to them – even if Ramaphosa loses the election and SA drops out of the WGBI, which is seen as inevitable next year.
“I think people conflate issues when it comes to understanding currency and bond markets – it seems that they try to draw a straight line between all the negativity and how the rand should be behaving,” says George Glynos, managing director of Econometrix Treasury Management Analytics.
“What we’re picking up from our extensive efforts to build specific models is that currencies can move in a very counterintuitive way.”
Firstly, the extent of a knee-jerk selloff in bonds following a WGBI exit is debatable as some of the outflows would already have taken place while the remainder would be “bled slowly” into the market to minimise disruption, he maintains.
Secondly, at least 40% of the holders in the WGBI were active managers who could exercise discretion.
Although many foreign investors would be forced to sell, the fact remains that there is a growing universe of sub-investment grade managers who will see value in South African government bonds, as they offer attractive yields by both developed and emerging market standards and offer a reasonable balance between risk and reward, Glynos says.
Local fund managers will find current yields “compelling” given that inflation in the country is low, and would likely absorb the flow from a WGBI expulsion, he adds.
Some could even use rand weakness as an opportunity to repatriate overseas investments into local bonds.
Lastly, when SA was first included in the WGBI in October 2012, market reaction was muted, suggesting that expulsion might be just as marginal.
“While expulsion from the WGBI cannot be considered a rand supportive event, the consensus explanation that it loses significant ground should be seriously reconsidered,” he says.
In a best-case scenario where Ramaphosa wins ANC leadership, the rand could appreciate back to R12.50 to the dollar, while the boost to business confidence could raise economic growth by a full percentage point, Glynos says.
He is not alone with his convictions. Rand Merchant Bank currency analyst John Cairns thinks that the rand could break through the key R13 to the dollar level if there is a favourable market outcome at the ANC conference.
Even if there were outflows of $10bn on a WGBI exit, the rand may handle it well as daily turnover in the market now amounts to $55bn, he says.
This article originally appeared in the 14 December edition of finweek. Buy and download the magazine here.
