Some commentators have boldly predicted that the rand will weaken to R60 to the dollar or, more simply, that the rand will crash, and that SA is closer to approaching the IMF for a bailout due to the current bleak economic prognosis.
On the rand crashing to R60/$, especially over the short to medium term, these commentators are outright sensationalist and have no plausible justification for such disproportionate levels. While economic growth remains at pedestrian pace, conditions are nowhere close to forcing SA to go to the IMF for a bailout. This is scaremongering.
Let me elaborate on each of the points, but first a picture is necessary of the economic backdrop that sparks these ideas. The current global economic growth outlook continues to slow down, with the risk rising of the US economy entering recession sometime over the next 18 months.
The US yield curve, as shown by the difference between three-month and 10-year bond yields, is the most inverted since 2006. The two-year relative to the 10-year yield curve briefly inverted on Wednesday — the first time since 2007. The past six US recessions have always been preceded by a yield curve inversion, so this development surely rings some alarm bells.
The global bond market is also screaming heightened risk. The quantum of global bonds with negative yields has increased to $16-trillion this past Wednesday, up by a whopping $2-trillion over the space of a week. This means global fund managers are happy to invest in securities that they know for sure will return less than what they invested if held to maturity. They must be worried about something: a global recession.
Growth in Chinese industrial output for July declined to its lowest in 17 years and retail sales came in below expectations. The UK and German economies contracted in the second quarter of 2019. The most recent purchasing managers’ indices, which measure the health of the manufacturing sector, is in contractionary territory for all but three of the major economies.
The global environment points to a risk-off outlook that will potentially result in capital outflows from emerging markets, including SA. More importantly, due to weak domestic growth, rising debt on state-owned enterprise bailouts (essentially Eskom), SA’s fiscal risks have increased. Moody’s is likely to change its outlook on the Baa3 rating — the last remaining investment grade rating — from stable to negative on November 1, followed by a downgrade to subinvestment grade in 2020.
While estimates vary, about R45bn will flow out of the bond market if Moody’s downgrades to subinvestment. The currency will weaken. But even with the risk-off trade in place, it is highly unlikely to go to R60 to the dollar. A look at about 20 countries that have lost investment grade since the early 1990s shows that equities, bond yields and currencies recover in the subsequent 12 months.
Over the short term, domestic real bond yields are likely to increase, which will attract capital inflows chasing yield, especially given the low yields in global bond markets. If a global recession occurs, and capital outflows and a domestic credit rating downgrade occur simultaneously, the rand could depreciate by 15%-30% over 12 months, which would take it to just more than R20 to the dollar.
As far as SA being close to approaching an IMF bailout, economic conditions are still far off meeting the requirements. Countries that go cap in hand to the IMF usually have a balance of payments crisis, banking crisis or funding problems. SA has none of these at the moment.
Less than 10% of the total debt portfolio is in foreign currencies and the country has about five months of import cover, well above the acceptable three-month level. Domestic capital markets are deep and liquid, and the Treasury has never had any issues raising funding.
The domestic banking sector has always been conservative in not raising a significant portion of its capital in foreign currencies. While these factors indicate that SA has not yet fallen over the edge of the precipice, the economic outlook is dire and does require urgent economic reforms.
• Mhlanga is chief economist of Alexander Forbes.
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