The rand nosedived in a week of turmoil, but how did we get here and where are we going?
On 24 February 2022, the day that Russia invaded Ukraine, the rand was trading at R15.42/$. Since then, the local unit traded some 6% stronger, dipping below R14.50 at one stage. That the rand could maintain such strength in the face of local pressures such as a record unemployment rate of 35.3%, soaring fuel prices, the domestic electricity crisis and a factionalised ANC, indicates that it had been taking its cue from external factors with the key tipping point being the Russian invasion of Ukraine.
Commodities and the trade balance
The war in Ukraine has been a big driver of forex markets, especially in commodity-based developing countries, propelling commodity prices higher. Paradoxically, this has had a positive spin-off for the rand as the higher dollar inflows resulted in an improved trade balance and significant rand strength.
Not only that, compared to other emerging markets, South Africa maintains a relatively low exposure to Russia in terms of trade and investments, so traders have been rolling out of positions in countries such as Turkey and Egypt and into countries such as South Africa, Brazil and Argentina.
The soaring commodity prices might have boosted SA’s trade balance, limiting any negative effects of the war on our economic growth, but they have pushed inflation to the top end of the central bank’s tolerance level. Significantly, the higher oil price feeds through to most goods within the South African economy and dents consumer confidence.
At the same time, our imports from Ukraine, notably wheat flour and other cereals, are under pressure, leading to further food pricing pressure. South Africa imported US$34.051 million from Ukraine in 2020, $14.40 million of this being cereals, although this is a far cry from the nearly $180 million level of 2012.
Monetary policy tightening
With inflation on the rise, monetary policy continues to tighten. The interest rate environment going into the Russia-Ukraine war was already in a tightening cycle and South African yields are currently among the most attractive relative to our emerging market peers.
The expected SARB rate hikes have also been supporting the rand, even with growth for 2022 expected at only around 2% or lower.
But all good things come to an end …
The collapse, when it came, was swift and merciless. In the week after Easter, the rand gave up almost all of its gains for the year, slumping by 6% in four days and .
A perfect storm
A confluence of several factors saw the sudden currency collapse:
- Eskom implemented load shedding which reached Stage 4 at one point. The fragility of South Africa’s power grid is highlighted by the such a move and it underscores the negative impact that this will have on economic growth. Eskom remains a risk to the SA economy and the warning that the country faces a possible 100 days of load shedding through winter was perhaps the single greatest contributor to the decline. It is worth mentioning that the South African winter is not much longer than 100 days (three months) in any event.
· Intense flooding devastated KwaZulu-Natal, home to key South African ports. Some parts of the province were without water for 10 days following the floods while significant infrastructural damage was caused. It is estimated that it will take up to two weeks to clear the port backlogs while repairing infrastructure can take significantly longer while putting the fiscus under increasing pressure.
· The March 2022 inflation print came in below expectations, implying less upward pressure on local interest rates. While SA interest rates are likely to rise by 25 basis points at each MPC meeting this year, this is less aggressive than the expectations for the US hiking cycle thereby affording less support for the ZAR.
· The US dollar has also been strong as the market is pricing in quite a hawkish Federal Reserve in May.
· Precious metal spot prices have already peaked in early March and have since slipped between 5% and 15%, leaving the rand exposed on that front and a drop in the trade balance.
· The R10.3-billion raised from Barclays’ sale of a further portion of Absa shares has also hit the market this week, adding downward pressure to the ZAR.
How long can this go on?
On a fair value basis, the rand had been moving towards overvalued levels, which it historically it hasn’t been able to sustain.
However, the drastic and sharp weakening is unlikely to be sustained. The possibility that the US Fed will disappoint at its next rate meeting in May would support the rand. The local unit does feel toppish, and a consolidation is expected. We expect to see a range of R15.00/$-R15.75/$ in the short term.
1. United Nations COMTRADE database on international trade