South African Rand: The longer term outlook

With recent gains in the rand pronounced, we assess the longer term outlook for the domestic currency, considering recent events and factors which will affect the future appreciation or depreciation of the ZAR.

• Rand still trading in negative territory for the year
• Medium term ZAR strength, a correction of long term depreciation trend
• Gains in ZAR could be limited by global sentiment based on vaccine progress

Recent news of COVID-19 vaccine progress and approval, has seen a move back into higher risk emerging market assets such as the rand. The short term positive sentiment has been strong enough for the domestic currency to shrug off further downgrades by ratings agencies Fitch and Moody’s.

But while we have seen short term gains in the ZAR, the domestic currency still trades negative for the year thus far (against the majors).

Long term trend of depreciation for the ZAR in a correction phase

The below monthly chart of the ​USD/ZAR (from 2012 to current) shows a long term trend of depreciation for the rand against the dollar. The recent dollar weakness / rand strength serves as a short to medium term correction of this longer term uptrend for the USD /ZAR. It is unknown how long the euphoria associated with the coronavirus solutions will last, but if the risk on environment persists, R14/$ becomes a downside target derived from a confluence of both horizontal and trend line support.

The rand does remain undervalued on a purchasing power parity basis, which if further corrected in the short to medium term, could see the R14/$ support target achieved.

However it needs to be considered that recent ratings downgrades have been masked by vaccine influence on market sentiment. Further ratings downgrades are possible/ likely, which will be seen as a net negative for South Africa reflected in the rand. South Africa’s debt is fast approaching 100% of GDP and attempts at fiscal consolidation have failed to cast doubts amongst investors. So while we are in a corrective phase for the Rand against the majors, the long term trend for the ZAR is that of depreciation. This trend of depreciation is expected to eventually resume as soon as the shine on global risk on sentiment wanes and local sovereign debt risks grow. These factors suggest that the rand could move back into an ‘undervalued’ territory in terms of a purchasing power parity basis.

Factors which will support rand appreciation

• A rapid return to global economic growth
• A rapid return to economic growth domestically (>3% annualised)
• Fiscal consolidation
• Containment and reduction in government debt
• Structural reforms in SOE’s
• Policy certainty
• Progress in public sector wage disputes
• Credit ratings upgrade

Factors which will support rand depreciation

• A delayed return to global economic growth
• Low to negative growth for the domestic economy (<3% annualized)
• Ballooning twin deficits
• Continued burden of SOE’s on Fiscus
• Policy uncertainty
• Further Credit ratings downgrades

In Summary

The rand remains on a strengthening trajectory, aided by improved global risk sentiment. While the short to medium term euphoria could see the USD/ZAR moving as low as R14/$, this only serves as a medium term correction of what is still considered a longer term trend of depreciation for the domestic currency. For a sustained appreciation in the rand, fiscal consolidation is needed amidst a return to strong economic growth in South Africa. However the current trend of rising deficits, policy uncertainty, slow (and in some cases absent) implementation of structural reforms, for a country deep in recession, is expectant of the longer term trend of depreciation for the rand to continue.