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- ZAR weakens amid focus on political, economic threats to credit rating.
- Sell ZAR ahead of Feb budget says UniCredit as ratings fears will rise.
- Contentious plans for Eskom and tackling rising deficit to hurt ZAR.
The Rand will be vulnerable to further losses during the months ahead, according to analysts at UniCredit Bank, who are telling clients to sell the South African currency ahead of next week's budget statement from the government.
South Africa's currency must navigate a number of challenges during the weeks ahead including the budget on February 20, a parliamentary debate about a controversial land expropriation program on March 31 and a presidential election in May.
Between this Thursday and the end of March the government will remain under the watchful eye of Moody's, the last remaining agency to still rate South Africa as an "investment grade" borrower, as the government grapples with the threat posed to the public finances by national power utility Eskom.
UniCredit's strategists say this minefield of potential pitfalls is almost sure to encourage some forn of weakness in South African exchange rates and that clients would do well to bet against the Rand as a result.
"Buy USD-ZAR via two-month (15 April) forwards, currently at 14.00," says Kiran Kowshik, a strategist at UniCredit. "The 2M tenor covers the February budget statement (20th February), the parliamentary debate on a controversial land expropriation bill as well as the Moody’s rating update (both in late March)."
Above: USD/ZAR rate shown at daily intervals.
Moody's is not expected to issue its latest determination of South Africa's Baa3 credit rating until March 29 but it has already made its scepticism of government plans for righting the capsized ship that is Eskom known, and markets themselves will immeidately glean from the budget whether the government has addressed its concerns.
Finance Minister Tito Mboweni must put forward a credible plan to reduce South Africa's budget defiict this month, against a backdrop of weak economic growth and mounting-not-falling demands on the public purse.
He must also show Moody's that any financial support provided to Eskom will be offset by reductions in spending elsewhere in order for the budget to achieve a "ratings neutral" outcome.
Some say Moody's will change the rating outlook from neutral to negative in March, but leave South Africa at investment grade for now at least. But that may not be enough to prevent traders from taking precautions beforehand.
"We think there is more scope for a higher risk premium to be priced in the currency. An increased risk of a rating downgrade should place the currency under pressure given that there is a very large foreign investor exposure in the local bond market," Kowshik explains.
Almost half of South Africa's government bonds are owned by foreigners who have invested in a "global bond fund" and many of those funds benchmark themselves against the Citi WGBI local currency bond index. In other words they attempt to mimic its performance.
But the Citi WGBI only includes selected countries and all of those have so-called investment grade ratings. South Africa might be excluded from the benchmark if it is downgraded to "junk", which could then force relevant money managers into selling their bonds.
That would almost certainly mean lots of Rand being dumped on the market by investors seeking buy back their domestic currencies, leading to downward pressure on South Africa's exchange rate. Total South African government debt is equal to more than 50% of the nation's GDP.
"Optimism on reforms had been strong but could be prone to some disappointment: The government is currently involved in a turnaround strategy for Eskom – a critically important state-owned enterprise – ahead of the 20 February budget presentation. However, there is much resistance to the proposed revival plan," Kowshik warns.
Above: Pound-to-Rand rate shown at daily intervals.
South African labour unions are opposed to President Cyril Ramaphosa's plan to break up Eskom because they see it as a move that will almost certainly lead to job losses, while some politicians dislike it because steep electricity price hikes are a part of it and those could upset voters in an election year.
However, the real rub for the Rand is the plan that nobody wants has already been described as too light on detail and likely not good enough for Moody's, which means further work and acrimonious detail will need to come out in the budget statement.
Kowshik says the USD/ZAR rate could rise to at least 14.75, from just below 14 on Wednesday, during the coming months as investors walk away from or just bet against the currency ahead of the March rating review and subsequent election.
The government is on the hook for ZAR 350 bn (£21 bn) of Eskom's mammoth debt pile, which is equivalent to around 8.5% of national GDP, and the company now has severe financial challenges.
Revenue and cash flows that are not enough to cover its costs, while years of under-investment and poor management have left its capacity to generate and supply power to South African households greatly reduced.
But South Africa has a budget deficit that is approaching 4% of GDP and national debt that is now in excess of 50% of GDP, both of which are too high for the liking of ratings agencies. So it can't spend any more money on the struggling utility without first taking it from somewhere else.
Moody's gave South Africa a reprieve in March 2018 when it left the nation's credit ratings intact at Baa3, which is just about inside the "investment grade" threshold and only one notch above "junk status". It upgraded the outlook from negative to stable at the same time.
The agency said at the time it had been encouraged by a change in political leadership that came after Ramapahosa took over the presidency from Jacob Zuma. However, one of the main reasons it took heart from the transition is it hoped corruption would be routed from key institutions and struggling state-owned-enterprises would be fixed.
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