JOHANNESBURG – The rand has collapsed by nearly 20 percent against the greenback since March this year, while a basket of equity market-weighted emerging market currencies dropped by 6.2 percent over the same period.
It was evident that the rand’s surge against the dollar since President Cyril Ramaphosa’s election was unsustainable, as the local currency traded at a premium of nearly 7percent against the market-weighted emerging market currency index.
Foreign investors had a field day stripping out interest payments in hard currency terms, while the South African exporters – especially the mining industry – suffered as a result of the strong rand, contributing to exceptionally weak economic growth.
It was expected that the rand would retreat to normal levels and trade on par with the emerging market currency index – which it did until the end of July.
In August, however, two Gray Rhinos struck the South African economy simultaneously. The Gray Rhino has been coined by Michele Wucker in her book The Gray Rhino: How to Recognise and Act on the Obvious Dangers We Ignore as a highly probable, high impact, yet neglected threat, which when it charges, can cause severe damage. In simple terms she means why “do we ignore problems when the costs and consequences of failing to act are obvious?”
The first Gray Rhino to strike was on July 31, when Ramaphosa announced the decision of the ANC to change South Africa’s Constitution to expropriate land without compensation.
The uncertainty caused grave concerns about the outlook for South Africa, and was reflected in a sell-off of South African equities, bonds and the currency.
The impact of Ramaphosa’s land announcement on the economy is reflected in the seasonally adjusted Absa Purchasing Managers’ Index released earlier this week, which saw the index plummeting from a solid 51.5 points recorded in July to 43.4 points in August – its lowest level since August 2009.
The second Gray Rhino was the woes of emerging market assets as the crisis in Turkey deepened while Argentina’s weak economic fundamentals added impetus to the raging Gray Rhino’s attack.
The charge is further driven by President Donald Trump’s trade war where he wants to impose new tariffs on China and wants to sanction all countries doing business with Iran.
But just where does it leave South Africa?
The two Gray Rhinos have now joined forces and to put them in a boma will require extraordinary skills from the presidency, government, labour, business and all citizens. Furthermore, another Gray Rhino is lurking.
Although a shadow is only apparent at this stage, signs of a slowdown in global economic growth are already under way.
Although the governing party has softened its stance on the expropriation of land without compensation and the farming community is committed to engage with the government to find reasonable solutions, it will take a long time before business and consumer confidence are fully restored.
What is certain, though, is that South Africa will be seen as an emerging market with weak fundamentals and could be equally prone to sell-offs of assets in countries with weak fundamentals such as Argentina, Turkey and Brazil.
The big question is whether the land issue and the head winds facing emerging markets will lead to a further cut in South Africa’s rating by the credit rating agencies.
Here I take my queue from the South African bond market, and especially the yield on 10-year government bonds.
Although the nominal yield spread between South African bonds and US government bonds has risen by 100 basis points since April this year, the historical relationship between South Africa’s average credit rating (Standard & Poor and Fitch) since 1995 indicates that the yield spread by now should have been more than 9 percent compared to the current 6.4 percent given our credit rating.
Our real or inflation-adjusted 10-year government bond yield spread to US government bonds compared to the BRICS curve given the individual countries’ credit ratings indicates that South Africa’s real yield spread to US treasuries should be 5.5 percent instead of 4 percent currently.
In other words, it means that either our bond market is overpriced given our credit rating or the credit rating agencies are overestimating the risk of investing in South Africa.
What the bond market is saying is that global investors disagree with the rating agencies and still view South Africa as investment grade.
Yes, we may avoid a downgrade by the credit rating agencies.
The first Gray Rhino was created by Ramaphosa and his government by bringing forward the land issue.
To start dealing with it in earnest may eventually prove to be a master move by Ramaphosa.
You can expect the typical J-curve where things will deteriorate first before they get better.
The other Gray Rhinos are also likely to remain with us in the run-up to the US midterm elections in early November as the proverbial elephant in the room is likely to continue to invoke his emergency authorities.
Ryk de Klerk is an independent analyst. [email protected]
The views expressed here are not necessarily those of Independent Media.