Near-term dynamics appear to have turned more constructive for the South African rand for several reasons. As a result, USD-ZAR has reversed lower from a record high of 8.2050 below 8 and could yet see more weakness in the immediate term. The USD-ZAR chart looks bearish with a potential test of 7.70-75 at least. However, the medium-term outlook remains bearish on the rand given capital flight from South Africa.
Firstly, we examine the reasons that are causing the rand’s near-term dynamics to improve. In the first case, there is the expectation of significant currency inflows resulting from the merger between a consortium led by Anglo American and De Beers, which was recently agreed to by the shareholders of De Beers. As a result, the deal will lead to USD3.3 billion of gross capital inflows to the rand, reflecting the total cash payment to holders of De Beers’ rand-denominated shares. The FX transactions related to this will take place on 7 or 8 June, according to De Beers themselves.
Secondly, out of the emerging markets, South Africa was the big winner in the recent re-weighting by MSCI according to free float principles, with the result that we estimate the South African local markets should benefit from an extra inflow of USD450 million.
Thirdly, South Africa’s external sector has been performing particularly well of late, with the result that the country recorded a trade surplus of some ZAR9.6 billion in the first quarter. With an ultra competitive rand, export growth has been extremely strong in the first quarter.
Fourthly, the recent trend in inflation has been favourable, with the CPIX rate declining from around 8% to the latest reading of 6.7%. The South African Reserve Bank (SARB) is targeting a CPIX rate of between 3-6% for 2002. At this stage, it looks set to meet its target, increasing the monetary credibility of the central bank and thus further reducing the risk premium investors demand on South African assets.
Fifthly, fiscal credibility remains strong, with the government having turned in a highly respectable budget deficit of 1.8% of GDP for 2000.
Sixthly, privatisation proceeds this year are expected to amount to ZAR18 billion.
Lastly, the authorities continue to reduce the forward book. As of the last report, the Net Open Foreign (Currency) Position (NOFP) stood at USD9.0 billion. This compares to over USD20 billion at its peak and was down by some USD400 million from the previous month due to proceeds from an EUR-denominated bond issue.
There are caveats however to these rand-positive factors, not least with regard to the NOFP itself. While the gross inflow resulting from the Anglo-De Beers deal is expected to amount in a gross inflow of USD3.3 billion, the net inflow could well be substantially less. For a start, share-holders of De Beers who receive rand for their shares may elect to change this for another currency. Non-resident shareholders (excluding the take-over parties) would receive probably more than half of the USD3.3 billion cash payment. If we assume that all of them decide to convert the rand cash payment they receive into dollars (unlikely but the most conservative scenario), total net inflows from the entire transaction will still amount to about USD1.5 billion.To put this into perspective, the total portfolio and direct foreign investment South Africa received in 2000 amounted to no more than USD3 billion.
In addition, the SARB has a clear policy focus of eliminating the NOFP, which it rightly sees as a major structural weakness, both for South African financial markets and for the economy as a whole. The desire to use dollar inflows to reduce this structural weakness is likely to outweigh the central bank’s desire to see a stronger rand near term. In our view, the SARB could absorb a large portion of this gross inflow direct from the parties involved for that very purpose. In other words, the net inflow that actually goes through the FX market could well be substantially less than USD3.3 billion. The reduction and eventual elimination of the NOFP is fundamentally a positive for the economy and for the rand over the medium term; however, near term the implication that substantially less dollar supply may appear than previously expected is likely to be taken as a rand negative.
Looking at the medium- to long-term outlook for the rand, we remain bearish, once these one-off inflows are out the way. According to official data, capital outflows totaled ZAR17.4 billion between the inception of the investment allowance in July 1997 and the end of 2000. If ZAR17 billion in retail outflow has left the country according to the official allowance, how much “unofficial” outflow has there been? After all, the very existence of capital and exchange controls in a world of global capital markets means unofficial outflows. In any case, the official outflow coincides with the recent deterioration in South Africa’s capital account. For 2000, the capital account surplus was ZAR8.5 billion, down from ZAR29.5 billion in 1999. In Q4, last year it turned from a surplus of ZAR10.9 billion in Q3 to a deficit of ZAR1 billion. South African money continues to leave the country. The reasons for such out-flow are most likely outside of the remit of the SARB or the Ministry of Finance, involving the rising crime and job rates and concerns over possible spill over from Zimbabwe. AIDS is a further significant economic and social concern. The key dynamic for the rand remains capital flight and one-off capital inflows are unlikely to change that.
Callum Henderson is an Emerging Market Currency Strategist at Citibank/SSB.
The views expressed are the author’s own and are not necessarily shared by the bank or any of its affiliates.