Rand can strengthen below R17/$

If the Government of National Unity (GNU) delivers on its ambitious plans, the rand can strengthen below R17/$, and bond yields may drop into single digits. 

This is feedback from the head of fixed-income investments at Stanlib, Victor Mphaphuli, who said that if economic growth picks up to above 3%, the entire investment landscape will change. 

The GNU has provided investors with a rare chance to be positive about political developments in South Africa. For the past 30 years, the ANC has failed to regularly deliver a market-friendly president and policy framework. 

Mphaphuli said the main error the ANC government has made over the past decade is thinking that borrowing money from investors was a one-way street. 

“When a government borrows, it has to use that money for industrialisation and infrastructure to stimulate economic growth, create much-needed jobs and generate revenue to repay that debt,” he said. 

“Instead, it spent its borrowings on building a patronage economy, with ANC support bolstered by expanding social grants and wage increases for a ballooning public service, including SOE employees. As a result, SA’s debt-to-GDP soared.”

This resulted in S&P being the first rating agency to rank South Africa as sub-investment grade in 2017, followed by Fitch and finally Moody’s in 2020. 

Foreign investors exited South African bonds in droves, with their share falling from 44% to 25% of the total issuance. 

This made borrowing more expensive for the government and South African corporates. In 2012, SA’s average bond yield was 8.5%. As bonds were sold off, yields rose to 13% during the Covid-19 crisis. 

Today, the debt-to-GDP ratio is over 70%, and the government is turning to austerity measures to prevent further escalation. 

“The only positive throughout this mounting crisis has been the discipline and stability of the Finance Ministry, which fought back to win back its credibility. The markets are starting to reward them for that,” Mphaphuli said. 

GNU optimism

Mphaphuli is optimistic that South Africa’s fortunes can be turned around under the GNU, with the country’s future no longer dependent on one party but many. 

While South Africa is not out of the woods, he said that Stanlib can already see some blue sky. 

“We believe that if the GNU can work together, it will reawaken the economy, which will make it possible to bring down the debt-to-GDP ratio, achieve fiscal consolidation and build for the future.”

South Africa’s revenue generation will improve as long as the central government exerts spending discipline and makes the necessary policy reforms. 

Interest rate cuts from global central banks, which stimulate economic growth, will be another tailwind for domestic assets over the next two years.

Some of the positive possibilities of an effective government are that it could, in time, recover the country’s investment grade credit rating, which would attract foreign investment. 

The Reserve Bank would also have room to cut interest rates faster than already anticipated. 

Instead of growing at 0% to 1%, the economy can start to grow by 2% to 2.5%, protecting the currency and the fiscus.

A stronger currency delivers wealth effects for households as the GDP per capita increases and positively affects all asset classes.

For bond markets, there is potential for 10-year bond yields to fall to 10% or lower and for the rand to strengthen towards R17/$. 

If the economy delivers growth, investor confidence will improve over time, and businesses and asset managers will be encouraged to invest again in the domestic economy. 

Asset managers could even reallocate funds from offshore assets if they see better local opportunities. However, this will be a slow process as the country must demonstrate credibility along the way.

“This hopeful scenario is completely dependent on the longevity and effectiveness of the GNU. It demands that all those involved in it continue to work together for the betterment of South Africa.” 

“They have no choice. If they do not, history will judge them harshly, and the electorate will judge them even more harshly.”