The Rand Is a Buy Says Morgan Stanley, Even as Eskom Worries Pervade 

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- The Rand is a buy says Morgan Stanley, despite Eskom worries.

- As Fed retreat buoys emerging world, hopes of Eskom fix grow.

- But devil is in the detail ahead of Eskom plan, budget and election.

The Rand can continue its New Year rally for a while yet, according to analysts at Morgan Stanley, who are betting on the South African currency even as concerns about wobbly national power utility Eskom once again begin to draw the market's attention. 

International financial pressures on the Rand are expected to continue to ease over the coming weeks, and the now-market friendly African National Congress (ANC) is riding high in the polls ahead of an election that is due in May.

This gives South Africa the best chance it could hope to have of retaining its investment grade credit rating for the foreseeable future, which is key to the outlook for the Rand, although maintaining the rating is far from guaranteed. 

"We continue to monitor the situation around Eskom," says Morgan's Gek Teng Khoo. "Sentiment is bearish and if the management team is able to put together a credible plan to return to profitability, there could be a rally."

A key focus for the currency and bond markets over the coming weeks will be the state-backed power utility Eskom, which is on its knees financially and represents a significant risk to the taxpayer given large government guarantees of the company's debts. 

Eskom said at the National Energy Regulator of South Africa (NERSA) public hearings this week that it needs to lift the electricity prices substantially over the coming years in order for the company to become financially viable again. 

The requested increases are so large they have some analyst worried about a potential adverse impact on the broader economy.

"Exorbitant electricity tariffs are not only a risk to the inflation outlook but also to growth as energy-intensive sectors like mining and manufacturing would be hard-hit. Consumers would also be affected as excessive tariffs would eat into discretionary spending and weigh on household consumption," says Mpho Tsebe, an economist at Rand Merchant Bank. "Eskom has warned that failure to get above-inflation tariff adjustments and/or some of government’s support would put its going-concern status in jeopardy."

Above: Pound-to-Rand rate shown at daily intervals.

South Africa's government has a budget deficit equal to around 4% of GDP and a debt pile so large that rating agencies have long been concerned about whether creditors will ever get their money back. 

For this reason most have cut South Africa's rating to "junk" status but Moody's still has the nation rated as an investment grade sovereign, although this status is under constant review and liable to change at any point. 

Financial plans for the year-ahead due to be unveilled on February 20 as well as the financial position of Eskom will be key to any future decisions Moody's makes. The agency will want to see clear and credible plans to reduce the budget deficit put forward later this month. 

"Eksom is expected to present its turn-around strategy sometime this month, while National Treasury is likely to outline any form of support to the power utility in the 2019 Budget Review to be presented by the Minister of Finance on 20 February. President Ramaphosa will also probably touch on Eskom’s troubles when he delivers his State of the Nation Address," RMB's Tsebe says.

Bloomberg reported last week that government is entertaining a plan that will see the company split into three units, effectively making three companies out of the power generation, power transmission and power distribution operations. 

That would provide scope for more private sector finance and companies to become involved in the South African power industry, and may eventually lessen the financial burden on government, although resistance to the plan from labour unions is expected.  

Morgan Stanley says there is scope for a restructuring plan to be agreed for Eskom over the coming weeks and that this, as well as the recent change in Federal Reserve monetary policy, mean the rally enjoyed by the Rand this year could have further to run.

Above: USD/ZAR rate shown at daily intervals.

"We were stopped out of our short USDZAR trade during the US equity market sell-off in December but re-enter the trade as our call on USD gains traction," says Morgan's Khoo. "We lower our stop to 14.10."

Khoo says the USD/ZAR rate could decline to 13.00 over the coming weeks as sentiment toward the emerging world, and Rand in particular, improves. 

South Africa's currency has risen sharply against the U.S. Dollar and other developed world units this year as investors cheer a policy u-turn from the Federal Reserve (Fed) that has thrown emerging market economies a lifeline.

Fed officials took some heat out of the U.S. bond market late last year and this January when they told the world the central bank will be "patient" before raising its interest rate again, citing instability in the emerging world and an economic slowdown in China as a threat to the U.S. economic outlook. 

That was significant for the Rand because a strong Dollar and runaway U.S. bond yields had forced the Rand lower by a double digit percentage and driven capital out of and diverted it away from South Africa in the previous year. 

The USD/ZAR rate was quoted -0.31% lower at 13.37 Tuesday and has now fallen by -6.67% for the 2019 year-to-date, while the Pound-to-Rand rate was -0.33% lower at 17.41 and has declined -4.65% this year.

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