The rand has plunged deeper towards the down case as risk-off elevates on the increased threat of trade wars, and advancing global monetary normalisation, in a disappointing SA environment. This is according to Investec economist, Annabel Bishop.
The rand weakened overnight to R13.92/USD, R16.18/EUR and R18.44/GBP from yesterday’s close of R13.64/USD, R15.85/EUR and R18.07/GBP in an increasingly risk-averse environment following retaliation threats of new US tariffs (10% on US$200bn of Chinese goods, up from Friday’s threat of 25% on US$50bn of Chinese goods – China threatened 25% on US$34bn of US goods).
Bishop says global markets remain concerned about the threatened US-led trade war with China, an aggressive surge in protectionism focussed on increasing tariffs on US imports, and not just of Chinese goods (in line with President’s Trump pre-election campaign to attempt to bring manufacturing jobs back to the US via trade restrictions).
“However, protectionism can hurt the economy of the country imposing the tariffs just as much, if not more than the country having the tariffs imposed on it. This occurs not just by slowing economic growth and increasing inflation, but also by negatively impacting inputs in the manufacturing process of the country imposing the tariffs. Such a risk of slower growth in the world’s two largest economies is spurring risk-off,” Bishop adds.
She says that the rand is likely to remain volatile for the rest of Q2.18 and Q3.18 as it remains at risk from heavy portfolio outflows.
Since the global financial crisis to April 2018, US$2.5trillion flowed into EMs in a low US interest rate environment. But as the transition to neutral US interest rates becomes more advanced, the risk of outflows has been heightened. Foreigners sold R74.5bn of South African portfolio assets net of purchases in May and June, versus R32.3bn in net purchases for January to April 2018.
Bishop notes that US tariffs will also negatively affect South Africa, (SEIFSA, the Steel and Engineering Industries Federation of Southern Africa, calculates that US tariffs against SA steel imported into the US will cost SA R3bn, and R0.5bn in tariffs levied against SA aluminium with as many as 7 500 jobs estimated at risk).
“Added to this, is that SA is already disappointing investors with heavily indebted Eskom’s threatened load shedding and wage demands while SA remains the entities guarantor, the Q1.18 contraction in GDP and SA’s twin deficits where little work has been done so far to meaningfully reduce government debt and expenditure to date, or to fully eradicate state capture, as the individuals perceived to have driven it remain unprosecuted and the money has not been repaid – with Eskom in urgent need of recouping lost funds. Consequently, SA’s business confidence lags on weak fundamentals.”
With the focus on attracting fixed investment as the winter strike season blossoms with EWC (expropriation without compensation) looming, instead of prioritising the repair of SA’s fundamentals, the rand has weakened noticeably as the global support to EM currencies is withdrawn, and SA’s weak institutional environment is exposed, Bishop says.
While SA retains some competitive strengths (including prudent monetary policy, relatively sound financial system, well managed JSE, part of the global auto supply chain, mineral rich country which is finally making some small, positive progress on its mining charter and world class services sector) markets are overlooking these as they prove insufficient in the heightened global risk averse environment.
‘The down and extreme down cases of Investec’s scenarios include the risks of international and domestic shocks – which include the risk of an escalation in the US-led trade war with China and/or in geo-political conflict, as well as the risk of a faster than anticipated trajectory in US interest rate hikes, ECB monetary policy normalisation, or even a global financial crisis.”
Bishop concludes: “We have slightly reweighted the probabilities of South Africa’s scenarios towards the downside, reducing the up case to 10% from 12% previously, and increasing the down case weighting to 30% from closer to 25% (1% comes off the extreme down case). While we are not seeing an increased likelihood of additional credit rating downgrades and fiscal deterioration in SA, the global environment has become markedly more risk averse, which is negative for global growth as the threat of trade war has escalated.”