Four key drivers behind rand's rally, but can it hold?

“Three months ago we were staring down the barrel of total junk status,” said Warrick Butler, the head of emerging market spot trading at Standard Bank Group. “Today the mood has rotated 180 degrees.”

Here are the key drivers of the rally, and the risks that may derail it:

Political outlook

The election of Ramaphosa as ANC leader in December, setting him on a path to take over as head of state from the scandal-ridden President Jacob Zuma, has fuelled optimism that South Africa may avert further credit rating downgrades as the new leadership takes steps to root out corruption and stimulate the ailing economy.

Moody’s Investors Service is now less likely to lower the nation’s credit rating when it reviews its assessment in March, according to UBS Group. This month, the cost of insuring South Africa’s dollar debt against default for five years has dropped to the lowest level since 2013, when the nation still had investment-grade ratings from three major companies.

S&P Global Ratings and Fitch Ratings cut the country’s debt to junk in 2017 after the removal of Pravin Gordhan as finance minister in March. Moody’s put the nation on review for a downgrade in November.

A reduction of the local-currency bond rating to junk would trigger an exclusion of South Africa’s rand debt from Citigroup’s World Government Bond Index, sparking a selloff by investors tracking the gauge.

“Lacklustre growth, high unemployment and a deteriorating fiscal balance sheet require urgent reforms,” UBS strategists including Jonas David, who see the rand holding around R12/$ over the next year, wrote in a January 22 note.

“The leadership has a window of opportunity to implement changes ahead of the 2019 general elections. Recent developments lower the probability of another downgrade.”

Commodity prices

The commodity price boom of the past seven months is providing support for the rand. South Africa depends on raw materials - including precious metals such as gold and platinum, as well as industrial metals - for more than 50% of its export earnings.

That’s helped narrow the current-account deficit to 2.3% of gross domestic product, from as wide as 6.9% four years ago, easing pressure on the currency.

The shrinking external deficit “should limit the rand’s downside in times of less favorable global conditions”, according to the UBS note.

Investor sentiment

Investors are becoming more bullish on South Africa. After dumping almost R47bn of South African stocks in 2017, foreigners are buying Johannesburg-listed stocks at the fastest pace on record in 2018. That’s helped propel the benchmark index to an all-time high, led by shares of companies that depend on the local economy, such as banks and retailers.

“South Africa itself will be a big story this year,” said John Ashbourne, an economist at Capital Economics. “We think that the economic cycle as turned, and that growth will accelerate again this year. After years of downbeat forecasts, I think that a lot of analysts will be taken surprise by some good news out of South Africa.”

Dollar's demise

Continuing dollar weakness has supported most emerging market currencies including the rand, and that’s set to continue in coming months, according to Swedbank. A gauge of developing nation currencies is trading at its strongest level against the dollar in four years.

“Emerging markets are strong on the basis of a weak dollar and strong commodity prices,” said Hans Gustafson, the chief emerging market strategist at Swedbank.

“Our forecasts have been adjusted upwards for all emerging market currencies as the dollar has depreciated faster than earlier thought.”

Lurking risk

Even if Ramaphosa replaces Zuma as president, he may not be able to force through unpopular fiscal reforms, according to Informa Global Markets. The budget presentation on February 28 will tell whether the government has the will to curb rising debt and a widening budget deficit.

“We are reluctant to turn too optimistic on the rand just yet, given somewhat murky medium-term prospects,” said Natalie Rivett, a senior emerging market analyst at Informa.

“We would expect to see some faltering of the rand as we head closer to the February budget, which will be the next key risk event and could be the deciding factor as to whether Moody’s will deal a blow to the sovereign’s local credit rating.”