The US Federal Reserve’s announcement this week of the start of tapering of quantitative easing brings some certainty and is unlikely to undermine the financing of South Africa’s current account.
While the rand has weakened substantially this year as markets repositioned to price in the expected future advent of quantitative easing in the fourth quarter this was primarily due to a foreign sell-off of R28 billion of equities (net of purchases) to date, as investors factored in the risk of higher interest rates and slow economic growth next year.
The sharp slowdown in the growth rate has dimmed prospects, as has the suppressed nature of consumer confidence as the SA Reserve Bank signalled the possibility of higher interest rates in 2014.
With little reason to expect gross domestic product (GDP) growth at 3.5 percent year on year, foreign purchases of equities are unlikely to pick up enough to drive the rand back to its fair value of R8.50 a dollar.
The Federal Open Market Committee announced on Wednesday that the US Federal Reserve would taper its quantitative easing programme from next month.
This reduction from current monthly purchases of $45bn (R465bn) of US treasuries and $40bn in mortgage-backed securities to $40bn of US treasuries and $35bn in mortgage-backed securities is smaller than expected, implying that the tapering process could stretch for longer than previously forecast, and so be less disruptive.
The Fed committee holds eight scheduled meetings a year, and at a potential $5bn taper for each meeting in both government and mortgage bonds – $10bn in total – the eradication process could stretch over the whole year.
This slow taper would imply that the first hike in interest rates in the US will likely not occur before mid-2015.
The pace of tapering will depend on data – indeed, no path or timeframe was given and it is possible that at the next meeting no further taper will be announced.
The committee can adjust the path of tapering at will.
The timing of the first increase in US interest rates has now stretched out further for some committee members, with three now expecting the first hike in 2016, versus only two previously.
That quantitative easing tapering will now begin at a slow pace next month brought certainty to the market and so caused an initial relief rally in the rand. The consensus previously was that tapering would begin in March, and that it would be closer to $12bn a month or above, and so a slower taper starting sooner should not be seen as negative.
The rand strengthened to R10.25 a dollar on the tapering announcement, and then retraced to R10.37 and is likely to remain around the R10.30 level for the rest of the month.
We forecast a strengthening trend in the rand next year.
Foreigners sold R15bn of government bonds (net of purchases) in the fourth quarter up to Wednesday on expectations that the US would announce the beginning of its tapering then. The fact that tapering will be gradual and the first tightening in US monetary policy is still far off have relieved many concerns.
Both the Reserve Bank and the International Monetary Fund previously cited substantial capital outflows as foreigners sold off bonds and equities as a major risk to the rand and funding of the current account on the announcement of a tapering in quantitative easing. However, with tapering factored in, this fear of the authorities is likely to subside.
We continue to expect no hikes in domestic interest rates next year as consumer inflation expectations subside toward our forecast of an average of 5.4 percent on rand strength.
The current account deficit as a percentage of GDP remains large as the trade deficit has widened on the lack of marked acceleration in exports despite the rand’s weakness. Instead the weakness has translated into higher costs for imports, and so a wider trade deficit. The trade deficit, and so the current account deficit, should narrow as exports pick up.
Should this not prove to be the case, however, and strike action proves to be marked again, then the current account deficit will worsen. Without reform to the labour market, specifically reduced rigidities, there will likely be further work stoppages which undermine the export capacity of South Africa and so weaken the current account. This indeed may prove to be the biggest risk to the outlook next year.
The strengthening of economic growth in the US will improve demand for South African commodities, and this will aid the rand in its projected strengthening next year.
Annabel Bishop is the chief economist at Investec.