Weakening Rand and SA's financial outlook

On Monday, the Rand dropped to an all-time low of R17.91 to the US Dollar, many reports have highlighted. While the Rand recovered before the close of trading on Monday, ending the day at R16.65 to the US Dollar, there is concern about the country’s finances.

John Cairns, currency strategist at Rand Merchant Bank (RMB), noted that the Rand is currently being driven by local factors rather than the more usual offshore factors. “Investors appear to have lost faith in SA given slow growth and worries over the state of government finances.”

Furthermore, First National Bank (FNB) has highlighted that the recent reviews by ratings agencies, such as Standard & Poor’s, Fitch and Moodys, who have all downgraded South Africa’s growth forecast, as well as the increase in the US interest rate have resulted in a tough outlook for South Africa.

The Rand
When asked if the Rand could continue to weaken, Cairns said: “The Rand is very volatile at present and even the smallest shock could send it running again. However, the Rand is heavily oversold and very undervalued.”

Pieter Krügel, wealth manager at PSG Wealth, believed that the Rand will continue to weaken against major currencies in 2016, for two main reasons. These are the strength of other major currencies, such as the US Dollar as a result of the US interest rate hike, as well as the weakening of the Rand, due to current account & government spending deficit, labour unrest, and a commodities slump, among others.

According to Cairns, due to the inflationary consequences of the weak Rand, the South African Reserve Bank (SARB) will probably be forced to hike rates at the end of January. “We at RMB expect the MPC to hike by 25bp (basis points) later this month and they could even hike by 50bp.”

Arthur Kamp, investment economist at Sanlam Investments, revealed that the SARB is expected to increase interest rates through 2016, starting with the MPC (Monetary Policy Committee) meeting later this month.

However, Kamp believed that it is not clear how much of an increase we can expect. “But, should inflation increase to more than seven percent one would think repo rate hikes of one percent cumulative at least through the year.”

The outlook for 2016
Cairns pointed out that the weak Rand means higher inflation, higher rates, worse sentiment, and slower growth going into 2016.

Kamp revealed that in recent year, currency weakness has been attributed largely to waning domestic productivity levels as well as the sharp fall in South Africa’s export commodity prices. However, recently concern regarding fiscal sustainability and US interest rate hikes have been prominent.

In light of this, Kamp noted that monetary and fiscal policy response are expected to play an important role in the performance of the Rand during 2016. “The Reserve Bank’s real repo rate must increase and the National Treasury must show a meaningful decline in the government’s budget deficit in the years ahead. Given the palpable weak state of real economic activity this implies the gap cannot be closed by increases taxes alone. Government spending cuts are also needed.”

According to Krügel, economic growth is set to increase by one percent in 2016. Kamp agreed with Krügel that GDP (gross domestic product) growth is expected to be below one percent this year.

Kamp said: “A stagflationary* type of environment is expected for 2016. It is clear the economy is facing a period of adjustment as it has been unable to attract sufficient foreign capital to fund its wide current account deficit. A shift to a narrower current account deficit implies weak domestic final demand, probably including an outright decline in private sector fixed investment (returns on fixed investment are too low and business confidence is at its lowest level in two decades).”

The ongoing drought is expected to have an impact on the economy in 2016 as well. “The ongoing drought will have a major impact on food prices, which in turn will have a negative impact on inflation, which will ultimately hurt the economy,” explained Krügel.

Kamp added: “Rand weakness and higher food prices imply inflation could exceed seven percent by year-end 2016 (well above the six percent upper limit of the Reserve Bank).”

“The currency is trading far away from what we consider fair value. Historically, the Rand has tended to appreciate meaningfully following currency depreciation episodes of the magnitude seen in recent years. There are, however, no guarantees. The Rand may simply remain weak while inflation increases in the years ahead. Much will depend on whether or not South Africa’s policy response is adequate. Interest rate hikes are needed to contain inflation while the National Government Budget, to be published in February 2016, must reflect a path back to fiscal sustainability,” stated Kamp.

Investing in the current financial climate
Eric Enslin, CEO of FNB Private Wealth and RMB Private Bank, noted that the above factors mean that investors should consider diversifying their long term investment strategy, while at the same time minimising the risk associated with the current economic adversities.

“Investors with high exposure to equities would have already seen the need to diversify their portfolios as the local market has come under severe pressure over the last year. The main aim of diversification is to limit volatility or risk within your portfolio and thereby smooth returns over time,” explained Enslin.

He highlighted that diversification should take place across a variety of asset class, sector, geography and currency, among others. However, random diversification could result in uncertainty with regards to the outcome of the investment.
“The first step to healthy personal finances is a solid financial plan that is updated regularly, as the market and your personal situation changes. Consult your suitably qualified financial adviser in this regard,” added Krügel.

Furthermore, Krügel advised that people try to avoid debt going into 2016, as “we are at the beginning of an increase in interest rates, which will probably continue for the next couple of years.”
Kamp stressed that a policy response from government with regards to the economy is critical. “Failure to deliver a decisive, meaningful policy response is likely to lead to sustained macroeconomic instability with dire consequences for economic growth and inflation.”
 
*Stagflationary refers to sluggish economic growth coupled with a high rate of inflation and unemployment.