Since our last ZAR update, conditions in South Africa have improved markedly. Over the last two months, the number of new cases and the positive test rate have fallen dramatically, allowing the South African economy to lower its lockdown from level 3 to level 1 over the course of two stages. On August 15th, President Ramaphosa announced that the country will move to level 2 of the five-stage alert system, allowing the resumption of economic activity across most industries, while the nationwide curfew remained in place between 22:00 and 04:00. With a further stabilisation in conditions since the announcement, the lockdown level was lowered further on October 1st to allow for international travel to and from certain low-risk countries from three select South African airports.
The relaxation in lockdown conditions has naturally led to economic indicators pointing to increased business and consumer confidence as the economy rebounds from the effects of strict containment measures.
However, structural challenges remain in play for South Africa’s economy, which will ultimately cap the speed at which the economy fully recovers from the Q2 shock. This is represented in the limited rebound in the rand and SAGB curve.
South Africa’s strict lockdown not only brings down the number of new cases but also the positive test rate, allowing the economy to re-open to level 1.
The data represents the 7-day average of the daily new confirmed Covid-19 cases per million people
Source: European CDC, Our World in Data
STRUCTURAL CHALLENGES TO ECONOMIC RECOVERY OFFSETS REBOUND IN SENTIMENT OVER SA ASSETS
Investors will have to wait until the 28th October for an update on South Africa’s finances after Finance Minister Tito Mboweni requested a 7-day extension from Parliament on Wednesday 14th October. This is so the Treasury’s latest projections can take into account the government’s economic recovery plan. Released on the 15th of October, the recovery plan aims to generate 800,000 new jobs with an R13.8bn injection over the next three years, aided by a 3-month extension to the Covid-19 grant system. This will come as welcome news to the labour market, with unemployment officially sitting at 23.3% as of Q2. In reality, however, the true unemployment rate is much worse. The decline from 30.1% in Q1 to 23.3% in Q2 was largely due to a 13% reduction in the participation rate, brought about by discouraged workers leaving the job market.
In addition to job creation, the recovery plan set out two broad areas of investment for the government; infrastructure spending and energy security.
R360bn has already been put aside as part of the infrastructure programme aimed at housing, public utilities and network infrastructure, with a further R100bn set aside from the SA Infrastructure Fund. The total amount of infrastructure investment is projected at R1trn once accounting for fiscal multipliers and the estimated level of private investment. Achieving stable electricity production is the other cornerstone of the recovery plan. Loadshedding by Eskom has been a major constraint to South Africa’s economy over the last few years. The return of the measure recently due to electricity demand rising as the economy re-opens threatens to limit South Africa’s recovery. As such, the government’s recovery plan amounts to more urgent implementation of existing priorities. Within two years, the government aims to add 11,800MW of new capacity to the grid, half of which will come from renewable sources. Within 12 months, an additional 4,000MW will also be generated to ease capacity pressure on Eskom while grid maintenance work is carried out.
While on the surface the recovery plan seems to address key structural issues in the South African economy, the pledges haven’t appeased concerns in FX and bond markets. The reasoning is two-fold. Firstly, the latest commitments to driving growth through infrastructure investment and energy security are previous policy commitments that have been re-packaged. Secondly, the fiscal projections are yet to be released, as are the details around the implementation of said proposals. Talk is cheap in this sense and clarity around the mobilisation of pledges is needed for both the private sector and international financial markets to buy into the government’s vision. For now, this clarity isn’t forthcoming.
The next medium-term budget proposal on the 28th of October is unlikely to give enough of a reliable reading on the projection of the economy and the true scope for fiscal stimulus to appease financial markets concerns.
Foreign investors remain reluctant to pick up South African debt as fiscal and growth concerns remain in abundance
TURNING BEARISH ON THE RAND IN THE NEAR-TERM AS ECONOMIC PROGRESS REMAINS SLOW AND THE DETAILS OF FISCAL POLICIES REMAIN VAGUE
The view that fiscal pledges would take time to mobilise and that uncertainty surrounding the June medium-term budget projections was too high for financial markets to buy into was already baked into our previous USDZAR forecasts. The forecasts envisaged the pair closing out Q3 at the 17.00 level and the year at 16.80. However, after the rand finished Q3 close to our target at 16.75, we have since turned bearish on the currency until year-end, reflecting our new view of the near-term risks to global risk appetite, a bounce in the dollar post-election, and the lack of progress made in the South African economy, we have revised up our end of year call to 17.40. Our view that a risk rally will occur in the first half 2021 remains intact, however, with risks to the downside. Should the global macroeconomic climate improve, investor sentiment towards South African assets should improve despite the structural challenges to the domestic recovery remaining. The risks to this outlook are plentiful. In the near-term, the next medium-term budget proposal could prove decisive for both SAGBs and the rand, however, we don’t expect too much of a change in the active scenario outlined back in June.
Over the 6-to-12-month horizon, sustained lockdown measures leading to a downgrade in global growth expectations will weigh on risk assets, including the rand. This will delay our expectation of carry conditions returning in H1 2021 and the associated rally in ZAR.
Author: Simon Harvey, FX Market Analyst