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The South African Rand Stalls Near October High as Market Awaits Eskom Plan

Image © Government of South Africa

- ZAR stalls at October high on doubts over U.S.-China trade deal.

- Global factors tipped by Investec to dominate ZAR in days ahead.

- But Wednesday Eskom plan may provide impetus for fresh gains.

- Gov to set out Eskom debt proposals, says Moody's to be pleased.

- Eskom focus comes weeks off from budget, Moody's rating verdict.

South Africa's Rand stalled close to its October highs at the beginning of the new week amid waining optimism over the outlook for the U.S.-China trade dispute, although a government plan for dealing with the debt of Eskom could offer the currency a fresh lift when it's unveiled on Wednesday.

Emerging market currencies were on the back foot at the beginning of the new week as European investors got their first opportunity to scrutinise the agreement said to have been struck between the U.S. and China late last week. President Donald Trump said late Friday that he and Liu He, China's Vice Premier, had reached an agreement that partially addresses American concerns over intellectual property protections as well as Chinese currency manipulation. 

American banks are also set to be given access to the large and coveted Chinese market for financial services and China is also said to have agreed to buy much larger amounts of U.S. farm produce, although the accord has not yet been written on paper, much less signed or ratified in law. Investors had bid so-called risk assets higher throughout last week in anticipation of a deal and although the final product was broader in scope than was envisaged, its informal nature has unnerved markets this week.

Above: South African Rand performance Vs major rivals Monday. Source: Pound Sterling Live.

"Friday saw the rand comfortably pierce the R15.00/USD key resistance level, run towards R14.70/USD before bouncing back, but making key gains on the back of the USD weakness, as the intensity of safe haven flows moderated. Global growth perceptions remain a key driver for EM currencies," says Annabel Bishop, chief economist at Investec Bank.

Friday's agreement averts an increase in the tariff on around $250 bn of Chinese goods imported into the U.S. each year, which had been planned for Tuesday, although it doesn't address a new 15% levy that is still set to be imposed on all of China's remaining annual exports to the U.S. on December 15. And with both President Trump as well Vice Premier Li describing it as the first of a multi-phase deal, markets appeared to be nervous Monday that it could fall apart before the text is even written. 

October would not be the first time a supposed truce has been agreed in the 18-month long trade war only for it to fall apart within months, if not weeks, should such a thing happen heading into year-end.

Investec's Bishop says the ebb and flow of headlines relating to the trade deal, as well as the Brexit process and developed world interest rate policies, will dictate the trajectory of the Rand through much of the current month. 

"The rand could strengthen further in the run-up to October’s FOMC meeting, while additional ECB QE would be seen as supportive to the global growth outlook. However, a waning in financial market risk-on could see the rand back above R15.00/USD," Bishop warns. 

Above: USD/ZAR rate shown at daily intervals.

The Federal Reserve (Fed) has cut the Fed Funds rate twice in 2019 and the European Central Bank (ECB) has restarted its quantitative easing program, among other things, in an effort to protect their economies from an ongoing global downturn that is at least partly the result of the trade conflict. That's reduce bond yields in the major developed markets and boosted the attractiveness of high-yielding emerging market currencies like the Rand. 

Investors are betting heavily the Fed will cut its interest rate again before the year is out, potentially as soon as the end of this month, and if markets continue to express scepticism over the durability of last week's agreement ahead of the October 30 Federal Open Market Committee decision then the Fed might be more likely to pull the trigger. Such an outcome would support the Rand, although the fortnight heading into the decision could be a volatile one. 

"The rand could strengthen further in the run-up to October’s FOMC meeting, while additional ECB QE would be seen as supportive to the global growth outlook. However, a waning in financial market risk-on could see the rand back above R15.00/USD," Bishop warns. 

The Rand could draw fresh interest this week if President Cyril Ramaphosa was right when he told the Financial Times Africa Summit Monday that Moody's, the only agency to still assign South Africa an 'investment grade' credit rating, is likely to be pleased with his plan for dealing with the debt of ailing power utility Eskom. The company has Rs 450 bn of debt, RS 350 bn of which the taxpayer is liable for in the event of default. 

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

Rising costs and falling revenue have left Eskom all but insolvent and given the large debt liability, not to mention the dire state of the public purse, Moody's has been scrutinising the government's so-far hapless efforts at turning the company around. Moody's will announce its latest decision on South Africa's rating in early November, after the next budget plan is unveiled at the end of this month, and markets are currently looking for it to change the outlook on the rating from stable to negative. 

"Aside from global recession concerns and a higher risk aversion, the rand is particularly impacted by Moody's' upcoming rating review at the beginning of November. We have assumed that South Africa will be able to maintain its rating for the time being. If South Africa's sovereign credit rating should be downgraded to junk, this could trigger a significant ZAR depreciation. Over the short term, this is where we see the biggest risks to our forecasts," says Elisabeth Andreae, an analyst at Commerzbank

Eskom has long struggled to keep the lights in South Africa due to years of under-investment but the company provides 95% of all the nation's electricity, which means it's 'too big to fail'. It's unclear how much cash Eskom needs in order to survive although the government has said repeatedly it would like to break the company up into three separate firms dealing with power generation, transmission and distribution to customers with such an approach likely seeing private investors brought into the fold.  

If the government cannot come up with a viable plan for dealing with Eskom's debt at the same time as keeping South Africa's lights on then the 'investment grade' rating would be in even more jeopardy. And a loss of the rating would see investors, particularly those who benchmark to the Citi World Government Bond index, automatically forced into selling their government bonds. That would likely mean large outflows of foreign capital from South Africa.

Above: Pound-to-Rand rate shown at weekly intervals, alongside USD/ZAR rate (yellow line, left axis).

"The Finance Minister will not present his interim fiscal report (mini-budget) until 30 October. It is to be expected that the budget deficit in the coming fiscal year will significantly exceed the planned 4.5% of GDP. It remains to be seen how Moody's will react to a deficit close to or even above 6% and a further rise in government debt to well over 60%," warns Commerzbank's Andreae. 

A majority of analysts polled by Bloomberg this month said they expect the country to keep the rating. However, and for its part, Moodys has blown hot and cold in its outlook for South Africa. It marked down South Africa's most recent budget statement in February and followed up with another critical appraisal of the public finances in May, before panning in July, a government plan to provide fresh financial support to Eskom. 

But then, and despite its past comments, Moody's signalled at a 'Sub-Saharan Africa summit' organised by itself in Johannesburg last month that it could give the country a stay of execution next month. Lucie Villa, the agency’s vice president and lead sovereign analyst, was reported to have told attendees that the current 'stable' outlook on the rating means there's only a very low probability of a downgrade happening imminently. 

Commerzbank's Andreae forecasts the South African Rand will end the 2019 year at 15.0 relative to the U.S. Dollar, which implies weakness up ahead. The Pound-to-Rand rate is seen ending the year at 19.05, up from 18.61 Monday.

 

 

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