5 March 29 CURRENCIES ZAR VULNERABLE TO STIMULUS The local monetary and fiscal authorities efforts to deal aggressively with the local economic slowdown imply a worsening of the country s other problem, the severe external imbalance. This leaves the ZAR extremely vulnerable to further bouts of weakness. We keep our year-end forecast at 1.5 for now but continue to warn that the risks are significantly to the upside. Having broken the USD/ZAR9.85 1.28 range, the bias in the next month remains upwards our 1Q9 target remains 1.8. CONSIDERABLE ECONOMIC STIMULUS Governor Mboweni went to the World Economic Forum in Davos and came back very worried. He subsequently seems to favour aggressive rate cuts, apparently arguing for a 2bp cut at the February MPC and, after being outvoted, was even thinking of calling an interim meeting. The government is also doing its share, the 29/1 budget deficit expanding to 4% of GDP from virtually flat levels. Even individually these actions amount to substantial stimulus. The market expects the repo rate to fall to 6.5% by September the lowest level since the 198s, while the fiscal deficit is the largest since the mid 199s. Taken together, policy is probably set to become the most stimulatory in recent history! It is also more stimulatory than most: looking at the developed and emerging markets there are few countries where rate cuts are expected to be as deep as in South Africa and this will feed through much more strongly into the real economy given that the banking sector remains sound. NO IMPROVEMENT IN THE CURRENT ACCOUNT The considerable economic stimulus is necessary to help the economy, which is looking more dire by the day. The problem is that these measures are inconsistent with a sustained significant improvement in the current account position. January s trade data has already provided a taste of things to come. The R17bn deficit, the worst on record, was due mainly to a collapse in exports. Imports, in contrast, held up. These trends are expected to continue; exports suffering on the back of the global crisis, imports held up by stimulatory policy. OUR CORE VIEWS The ZAR is likely to remain under pressure in the coming months. We look for 1.8 on USD/ZAR by the end of March End-9 USD/ZAR forecast: 1.5 End-9 EUR/ZAR forecast: 13.65 Trade to remain volatile with a USD/ZAR range of 9. 12. for the year. Risks are to the upside 1bp rate cuts in April and June followed by two 5bp moves Current account to contract to 6.5% of GDP in 29 Economic growth to slow to.7% this year Figure 1: Risks remain biased toward ZAR weakness 15. 12. 9. 6. 3.. 2 22 24 26 28 21 EUR/ZAR USD/ZAR Table 1: ZAR forecasts (end period) Quarterly 1Q9 2Q9 3Q9 4Q9 USD/ZAR 1.8 1.5 1.5 1.5 EUR/ZAR 13.5 13.44 13.55 13.65 GBP/ZAR 15.12 15.2 15.12 15.23 JPY/ZAR.11.15.15.15 Annual 29 21 211 212 USD/ZAR 1.5 1.3 1.7 1.37 EUR/ZAR 13.65 13.39 13.1 13.48 GBP/ZAR 15.23 15.45 17.12 17.63 JPY/ZAR.15.98.96.99 Source: RMB FM Research. See page 5 for full forecasts. John Cairns john.cairns@rmb.co.za +27 ()11 282 8656 Nema Ramkhelawan nema.ramkhelawan@rmb.co.za +27 ()11 282 8519
5 March 29 The result is that the trade account should actually worsen this year. The current account at least will contract; the last month has provided clear evidence that dividend payments by local corporates are slowing rapidly, and this diminishes the income payments to foreigners that make up the largest share of the deficit. Nevertheless, the bottom line is that the substantial economic stimulus being seen implies that the country s external imbalances aren t set to improve significantly enough. Our forecasts remain for a 6.5% current account deficit this year, and much the same next. NO LONGER ADJUSTING OUR IMBALANCES Such large current account deficits are unsustainable. The funding of the deficit implies South Africa s foreign debtor position is deteriorating sharply. This position is still not nearly as bad as in many other countries but we can t keep accumulating foreign liabilities forever. Something will have to give. We had hoped that the economic downturn would allow the country s imbalances to be worked out. This would have required tight policy to keep domestic expenditure in check, and a weak ZAR to get the tradable goods sector to respond. But tight policy no longer looks likely. This implies that any adjustment would be forced by the market essentially through currency weakness caused by a shortage of capital inflows. BORROWING TO KEEP THE PARTY GOING The government looks likely to step in and help deal with this problem by raising considerable debt offshore. The budget announced a US$1bn per year offshore issuance plan. Transnet has plans for an offshore bond of US$2bn. Most importantly, Eskom wants to raise R9bn from offshore sources be it through loans or trade financing or funding from development institutions. Add in some other minor funding and the total is almost US$15bn in funding in the next three years less around US$2bn in repayments due. This helps finance the current account deficit but at the expense of running up the country s external debt, which should surpass US$5bn this year and come close to US$6bn by the end of next. This would take the gross foreign debt-to- GDP ratio from the current 15% to close to 3%. This ratio is again a lot lower than many other countries but reflects a sharp turn in the trend towards repaying debt. Essentially, South Africa will continue to live beyond its means through explicit debt financing! LEAVING THE ZAR VULNERABLE With the external imbalance not set to improve, the ZAR will remain vulnerable to sudden losses of confidence. Our core view remains that the unit will be able to hold up through the year. As we set out in the next section, we do see scope for some short-term weakness with USD/ZAR going to 1.8. But our year-end view remains 1.5. We do expect to see a wide Figure 2: Expected stimulatory monetary and fiscal policy 24 16 8-8 Interest rates (%) Budget deficit (% of GDP) -16 198 1985 199 1995 2 25 Source: I-Net Bridge, SARB, RMB FM Research Figure 3: Falling dividend payments to help the current account Rbn 5-5 -1-15 -2 24 25 26 27 28 29 Source: I-Net Bridge, RMB FM Research Figure 4: South Africa s net external debtor position % of GDP 75 6 45 3 15 Source: SARB, RMB FM Research Income acc.bal. Services acc. bal. Trade acc. bal. Transfers 197 198 199 2 21 RAND MERCHANT BANK page 2
5 March 29 range in the year, our forecast remains 9. 12., which incorporates bouts of severe ZAR weakness. The risk to all these forecasts lies to the topside, all the more so now that South African policy is directed towards rapid growth. RATE POLICY COULD HANDLE SOME WEAKNESS At the extreme it is possible that ZAR weakness restricts rate cuts. Two of the previous three cutting cycles were, after all, brought to an end by currency weakness. And other countries have already run into this problem, those in Eastern Europe in particular, but also other emerging markets such as Mexico. Moderate ZAR weakness, however, probably wouldn t constrain the SARB from cutting rates. In fact, weakness could even be welcomed by the authorities as it would help get the export sector going again. The question is what constitutes moderate? Our guess is that the SARB would keep cutting even with USD/ZAR at 11.. But if USD/ZAR hits 12. then the 1bp cut at the June meeting could come into question. THE MONTH AHEAD: SIGNIFICANT RISK The coming month is unlikely to be easy for the ZAR. Immediate pressures continue to come from the slide in global equities. Currencies have managed to largely ignore this decline but the risk is that a late catch-up will have to be played at some time or other. Watch the moves on EUR/USD in particular if this pushes lower in line with equities then we can expect to see more spill-over into risky currencies such as the ZAR. We maintain our end-1q9 USD/ZAR forecast of 1.8. Data event risk remains as large as ever but the stability of the US financial sector still takes centre stage, notably with regards to possible nationalisation of the parts of the industry. Also watch comments from the ECB for hints on how low they will take interest rates and how this impacts the EUR. Eastern European problems could likewise spill-over. Through the month, a lot of attention will shift towards the expected change in the international financial architecture. Finance Ministers from the G2 meet mid-march to lay the groundwork for the leaders summit in early April. This could possibly be the start of the largest changes to the global financial system since the Bretton Woods agreement of 1944 that established the IMF and World Bank. Figure 5: Net general government offshore issuance Rbn 4 3 2 1-1 199 1995 2 25 21 Source: SARB, RMB FM Research Figure 6: Rising foreign debt levels % of GDP 75 6 45 3 15 1985 199 1995 2 25 21 Source: SARB, RMB FM Research Figure 7: US equities present risks to the ZAR 12.5 11. 9.5 USD/ZAR Debt to GDP % Forecast Debt US$bn (RHS) Forecast Dow Index Futures (RHS) US$bn 6, 8, 75 6 45 3 15 1, The question locally is whether there will be an interim rate meeting? After the worse-than-expected inflation data, we suspect not. We continue to look for a 1bp cut at the April meeting. 8. 6.5 5. Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 12, 14, 16, RAND MERCHANT BANK page 3
5 March 29 CURRENCY FORECASTS AND GRAPHS USD/ZAR forecast and forwards EUR/ZAR forecast and forwards 14. 17.5 12. 15. 1. 12.5 8. 1. 6. 7.5 4. 2 22 24 26 28 21 5. 2 22 24 26 28 21 GBP/ZAR forecast and forwards JPY/ZAR forecast and forwards 2..14 17..12 14..1 11..8 8..6 5. 2 22 24 26 28 21.4 2 22 24 26 28 21 Table 5: RMB currency forecasts 1Q9 2Q9 3Q9 4Q9 29 21 211 212 213 USD/ZAR 1.8 1.5 1.5 1.5 1.5 1.3 1.7 1.37 1.68 EUR/ZAR 13.5 13.44 13.55 13.65 13.65 13.39 13.1 13.48 13.88 GBP/ZAR 15.12 15.2 15.12 15.23 15.23 15.45 17.12 17.63 18.15 JPY/ZAR.11.15.15.15.15.98.96.99.12 AUD/ZAR 7.2 6.83 6.83 6.83 6.83 7.21 7.5 7.26 7.47 NZD/ZAR 5.4 5.46 5.62 5.78 5.78 6.18 6.4 6.22 6.41 CHF/ZAR 9. 8.96 8.96 8.95 8.95 8.64 8.45 8.7 8.96 NOK/ZAR 1.5 1.49 1.51 1.52 1.52 1.49 1.59 1.63 1.68 SEK/ZAR 1.17 1.19 1.22 1.24 1.24 1.34 1.41 1.45 1.49 CAD/ZAR 8.37 8.4 8.57 8.75 8.75 8.58 8.39 8.64 8.9 CNY/ZAR 1.58 1.56 1.59 1.61 1.61 1.58 1.71 1.96 2.1 INR/ZAR.28.198.24.21.21.26.224.23.23 BRL/ZAR 4.5 4.38 4.47 4.57 4.57 4.48 5.4 5.19 5.19 BWP/ZAR 1.26 1.25 1.24 1.24 1.24 1.2 1.2 1.21 1.22 NEER 54.45 55.24 54.94 54.65 54.65 55.73 56.63 55. 53.43 We can provide a separate excel file that includes the full history of all these currencies plus monthly, quarterly and annual forecasts, both for end-period and period average. This is available to clients on request. RAND MERCHANT BANK page 4
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5 March 29 RMB FINANCIAL MARKETS RESEARCH AFRICAN RESEARCH Celeste Fauconnier: Politics +27 11 282-1923 SOUTH AFRICAN RESEARCH Commodities Research Josina Oliphant +27 11 282-4823 Credit Research Jana Kershaw +44 2 7939-1756 Elena Ilkova +27 11 282-122 Currency Research John Cairns Nema Ramkhelawan +27 11 282-8656 Data Analyst Raymond Sithole +27 11 269-9969 Economic Research Ettienne le Roux Kay Walsh +27 11 282-8726 Fixed Income Research Bulent Badsha +27 11 282-4146 Please email us at ficc@rmb.co.za or see www.rmb.co.za/ficc for more information. To subscribe to research, please email research@rmb.co.za Rand Merchant Bank and First National Bank are divisions of FirstRand Bank Limited DISCLAIMER This research has been written by the financial markets research team at FirstRand Bank Limited (acting through its Rand Merchant Bank division) ( the Bank ). Whilst all care has been taken by the Bank in the preparation of the opinions and forecasts and provision of the information contained in this report, the Bank does not make any representations or give any warranties as to their correctness, accuracy or completeness, nor does the Bank assume liability for any losses arising from errors or omissions in the opinions, forecasts or information irrespective of whether there has been any negligence by the Bank, its affiliates or any officers or employees of the Bank, and whether such losses be direct or consequential. Nothing contained in this document is to be construed as guidance, a proposal or a recommendation or advice to enter into, or to refrain from entering into any transaction. This research contains information which is confidential and may be subject to legal privilege. It is for intended recipients only. If you are not the intended recipient you must not copy, distribute, publish, rely on or otherwise use it without our consent. Some of our communications may contain confidential information which it could be a criminal offence for you to disclose or use without authority. If you have received this communication in error, please notify us at the address below and destroy the communication immediately. This communication is not intended to nor should it be taken to create any legal relations or contractual relationships. The Bank is an Authorised Financial Service Provider under South African law but is not authorised and regulated by the Financial Services Authority in the UK ( the FSA ). Any protection afforded by the rules of the FSA does therefore not apply. FirstRand (UK) Limited is a co-subsidiary of the Bank. Both companies are owned by FirstRand Limited, a company listed on the Johannesburg Stock Exchange in South Africa. FirstRand (UK) Limited is authorised and regulated by the Financial Services Authority to provide arranging and advisor services. RAND MERCHANT BANK page 6