South African Rand will take its Next Cues from Cabinet Lineup says Goldman Sachs

Image © Government of South Africa, reproduced under CC licensing

- ZAR supported in tough global market by election results, ANC win.

- Shape of Ramaphosa's cabinet now key to reforms and ZAR outlook.

- Concrete reform progress may be necessary before more ZAR gains.

The Rand scored a home run against the U.S. Dollar on Tuesday as risk assets recovered from earlier losses but the South African currency in the months ahead will depend heavily on the composition of President Cyril Ramaphosa's new government, according to analysts at Goldman Sachs.

Goldman Sachs forecasts a gain of almost five percent for the Rand before year-end, although the bank says this and the outlook for the currency could change on May 25 when President Cyril Ramaphosa is expected to determine the makeup of his next cabinet.

Financial markets are ultimately looking for a strong lineup of reformers who're likely to be competent as far as the public financese are concerned while in government, as well as committed to eliminating the corruption and graft that's damaged South African and international confidence in the nation's institutions and economy.

"On the positive side, support for the populist EFF stands at the lower end of the range of expectations, and the more “market-friendly” DA at the upper end. As a result, the Rand has weathered the escalating storm of trade tensions quite well and outperformed EM peers over the last few days," says Zach Pandl, co-head of global FX and emerging market strategy at Goldman Sachs, in a recent note.

Above: South African election results. Source: Investec Bank.

Pandl's comments came after a partial count of votes cast in the Wednesday 08, May general election showed Ramaphosa's African National Congress having won around 57.5% of the national vote, up from 53.9% in the 2016 municipal election but down from the 62.2% achieved in the general election of 2014.

The result was also below the lofty 60% share of the vote that had been predicted by some opinion polls ahead of the ballot and has resulted in the loss of 19 parliamentary seats for the African National Congress.

But, nonetheless, Pandl and markets have been pleased by the fact the radical Economic Freedom Fighters saw their vote share increase but only to a number that was at the lower end of the range predicted by various opinion polls.

The party has advocated a number of controversial policies, some of which might breach international human rights laws if implemented, including a much more radical version of the government's existing land expropriation policy.

"Should the market volatility intensify, there is a risk that this relative outperformance may leave the rand more exposed given its typical exposure to risk sentiment, especially in case of any disappointment on the local political front," Pandl warns, in a Friday note to clients.

Pandl forecasts the USD/ZAR rate will decline to 13.50 before year-end, from 14.20 Tuesday, and that the Pound-to-Rand rate will fall from 18.35 Tuesday to 17.43 by year-end.

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

South Africa is under pressure to reduce its budget deficit and national debt pile, both of which have risen to levels that are unnaceptable to ratings agencies. The only major rating firm to still have South Africa as an 'investment grade' borrower is Moody's, but there's no guarantee the rating won't be cut at a later date.

The government is caught between a rock and a hard place because of the weak economy, which could be further damaged if the government was to drastically reduce its spending without managing to incentivise a pick-up in activity elsewhere.

Ramaphosa and his new cabinet will also need to manage the ailing national electricity monopoly that is Eskom. South African taxpayers are on the hook for ZAR 350 bn of the Eskom's debts, given guarantees made by previous leaders, and the company is now failing.

"Economic growth weakened over the majority of this decade, and prospects have been seen to be very weak for SA," says Annabel Bishop, chief economist at Investec Bank. "Threats to private sector property rights proliferated under the increasingly extreme left-wing proposed policy making on agriculture, foreign and domestic fixed property investment since 2009, resulting in uncertainty and so weakening investor confidence."

Above: USD/ZAR rate shown at daily intervals.

Hopes are now high that Ramaphosa, a billionaire businessman who's seen as 'market-friendly', will be able to make the changes necessary to not only enable the survival of Eskom but to improve confidence in government and the economy among South African and international businesses.

Only when investor confidence picks up, will domestic and international investment spending pick up enough to support a durable recovery of the economy from a decade of anaemic growth.

But given false dawns in the past, Investec's Bishop says it might be year-end before currency market becomes willing to support the Rand in a bigger way.

Bishop says it might be year-end before currency market becomes willing to support the Rand and forecasts the USD/ZAR rate will reach 13.90 by year-end, modestly below Friday's 14.39.

Meanwhile, the Pound-to-Rand rate is seen rising even further over the remainder of the year, from 18.33 Friday to 18.65 before the end of December.

"Having been disappointed to some degree on the pace and extent of reforms in 2018, markets will likely hold back from a repeat of last year’s Ramaphoria until substantial gains have been made," Bishop says. "With market and private corporate sector trust having been severely damaged over the majority of this decade, it will take time for trust to be restored."


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