Johannesburg - The plunge in the rand to an all-time low of almost R18 to the dollar yesterday creates the risk of an interest rate hike later this month when a key central bank committee meets.
At the same time, the rand’s collapse means that South Africa is moving closer to a recession and possible credit-rating downgrade to junk and as investors lose faith in the ability of government to stem the slide.
There was a “very distinct risk” that the Reserve Bank would increase increments of future rate rises to 0.5 percent from 0.25 percent, Nedbank head of strategic research, Mohammed Nalla, said.
“If the rand continues on this kind of trajectory, you may well see a 0.5 percent hike at the next meeting and potentially followed up with similar hikes at any subsequent meeting. I don’t think higher interest rates will alleviate pressure we are seeing on rand,” Nalla added.
The 9.9 percent slump in the rand was the most since 2008 and the biggest of emerging markets and major currencies tracked by Bloomberg.
The rand plummeted by the most in more than seven years yesterday, bonds tumbled and stocks slid as market turmoil in China and a drop in US stocks deterred risk-taking.
The rand’s slide yesterday probably came after “a combination of stops and margin calls caused mass capitulation” by Japanese retail investors, Gareth Berry, a foreign exchange strategist at Macquarie Bank in Singapore, wrote in a research note.
Nalla said investors would look to President Jacob Zuma’s State of the Nation speech next month for signs of policy response “to what is effectively resulting in a crisis for South Africa”.
There might be “fairly sharp” tax increases in the Budget next month to counter credit-rating risk; that would raise prospect of recession, keeping the rand on the back foot, Nalla added.
The Reserve Bank will announce its next interest rate decision on January 28.
The central bank hiked its key repo rate by 0.25 percent in July and November.
Turning to the risk of credit-rating downgrade to junk, policymakers are running out of options on how to ease the crisis.
Worsening debt levels and the threat of credit-rating downgrades mean Finance Minister Pravin Gordhan has limited room to veer from his budget targets by boosting spending.
“With large parts of the economy already in recession, it looks like a certainty” that the economy would contract, George Herman, the head of South African investments at Citadel Investment Services, said yesterday.
“I have no doubt in my mind that we will be downgraded to sub-investment grade,” he said.
“The reality is that our fundamentals, which were already under pressure last year, have now been pushed over the tipping point by the dramatic weakening of the exchange rate.”
While South Africa’s economy narrowly avoided a recession in the third quarter, growth has been under pressure because of electricity shortages, weak global demand, plunging metal prices and drought.
The central bank projects the economy expanded 1.4 percent last year, the slowest pace since the 2009 recession.
Bank of America Merrill Lynch yesterday cut its 2016 growth forecast by 1 percentage point to 0.4 percent.
“The big problem is, now that we’re moving into this sub-investment grade environment, just how much can the Reserve Bank put through in terms of its rate hikes,” Matthew Sharratt, an economist at Bank of America Merrill Lynch in Cape Town, said.
“If you’re going to grow at 0.4 percent, the risk of fiscal consolidation being delayed further is exceptionally high.”
The government has struggled to rein in public debt as growth slowed, prompting credit-rating downgrades in the past two years.
Gross debt has surged to almost 50 percent of gross domestic product from 26 percent in 2009 when Zuma came to power.
Standard & Poor’s (S&P) cut the outlook on South Africa’s BBB- credit rating to negative from stable last month, indicating it may downgrade the nation’s debt to junk.
Fitch Ratings has an equivalent rating of BBB- with a stable outlook, while Moody’s Investors Service rates South African debt one level higher at Baa2 rating.
Sharratt said the country was “likely to lose its investment grade by the middle of the year from S&P, and possibly Fitch by the end of the year”.
The South African currency has been hurt by a slump in commodity prices, lacklustre economic growth and rising US interest rates.
Losses in the rand accelerated in December after Zuma unexpectedly fired his finance minister only to alter the decision days later, while the tumultuous start to the year in China has further damaged sentiment. South Africa sold 37 percent of its exports to China in 2014.
The benchmark all share index dropped 1.2 percent to 47 499.57 points, the lowest since December 14, as more than five securities tumbled for every one that rose.
The index ended up 0.45 percent at 48 322.68 points. Yields on rand-denominated government bonds jumped 17 basis points to 9.71 percent.
“The huge spike in risk aversion last week, poor liquidity and position liquidation have hit the rand,” said Robert Rennie, the global head of currency and commodity strategy at Westpac Banking in Sydney.
The rand plunged to its all-time low shortly after midnight in Johannesburg. Data compiled by Bloomberg showed that offers to buy the rand against the dollar dried up around 7.04am Tokyo time.
China strengthened the yuan’s reference rate slightly for a second day yesterday after an eight-day run of reductions that sent shock waves through financial markets, while swings in local asset prices have revived concern about the government’s ability to manage an economy set to grow at the weakest pace since 1990.
The rand might again test the R17.50 level per dollar and any rallies in the currency would be short-lived as investors shunned developing nations, Standard Bank analysts, including Walter de Wet and Shireen Darmalingam in Johannesburg, said in a note.
The current account and budget deficits were likely to weigh on the currency and the rand’s uncontrolled depreciation might cause the central bank to increase interest rates by 50 basis points at its monetary policy committee meeting, they said. “It is hard to see the rand pull back on a sustainable basis,” the analysts added.
“In recent weeks we have seen South Africa’s real effective exchange rate fall sharply to levels last seen in 2001 and 2008. We note that in both 2001 and 2008, amid a rand slide, the South African Reserve Bank embarked on a fairly aggressive rate-hiking cycle.”
Adding to the economy’s crunch is the worst drought since 1992 that has boosted food costs and pushed the farming industry into recession.
“The drought story has definitely got worse, maize prices are up at very high levels so food inflation is going to be one of the major themes and very problematic for the Reserve Bank,” Malcolm Charles, a portfolio manager at Investec Asset Management, said.
“Our economy has been so decimated over the last couple of years.”
The price of white maize, a staple food in southern Africa, has more than doubled on the SA Futures Exchange in the past year.
As a result of the weakening rand, the price of wheat quoted on the SA Futures Exchange increased by 2 percent or by R100 to R5 065 a ton.
“This morning’s price gains are linked to the rand/dollar weakness,” Wandile Sihlobo, an economist at farmers’ lobby group Grain SA, said.
The price of yellow maize, sunflower and soya bean rose but the white maize price on the futures exchange fell.