Rand had a strong rally – but there is a big threat

The rand strengthened to a one-year high, but weak economic data from China will potentially result in a weaker local currency in the coming months and over the long term. 

This is because China is the largest importer of South African goods, particularly minerals, and thus a vital source of foreign exchange earnings for the country. 

Often, what happens in the US or China is much more relevant to the relative value of the rand versus other currencies than what happens in South Africa. 

Many analysts have focused on the outcome of South Africa’s election at the end of May and the formation of the Government of National Unity (GNU) as the main driver behind the rand’s strength in recent months. 

While local politics has resulted in increased foreign investment in local assets, economic data from China has also boosted the value of the rand. 

At the beginning of June, Lings noted the steady improvement in China’s economic data that supported the local currency. 

“It’s not as if China is doing fantastically well,” Lings said. “It’s just that at the end of last year, China seemed to be in significant trouble, but during this year, they’ve initiated several reforms.”

Overall, these reforms have improved investor confidence in China and have stimulated its economy. 

“That’s helped to get a better feel around Chinese economic performance during the course of this year and into next year,” he said. 

Improved economic performance from the world’s second-largest economy tends to result in an uptick in commodity prices as it is the largest consumer of many resources. 

As a large commodity exporter, South Africa benefits, with expected improvements in foreign currency earnings and economic growth boosting the rand’s value. 

In particular, Chinese demand for South Africa’s mineral exports is a vital source of foreign exchange earnings for the country. 

However, this appears to have shifted significantly in recent weeks as China’s economy has shown signs of weakening. 

China’s GDP grew by 0.7% quarter-on-quarter in the second quarter of 2024, which was significantly slower than the prior quarter’s expansion of 1.6%. This is China’s weakest growth rate since the second quarter of 2022.

This shows that the country struggles to maintain the momentum established during the year’s first three months. The government’s effort to boost household consumption has been relatively ineffective. 

The pronounced slowdown in economic activity in the second quarter of the year has intensified concerns that Chinese economic growth could miss its target growth of 5% this year. 

The economy is currently forecast to grow by 4.8% in 2024 before moderating to 4.4% in 2025. An improvement in household consumption and stabilisation of the property sector is key to re-invigorating the Chinese economy.

While the current supply-centric policies and limited economic rebalancing can sustain 4% economic growth in the short term, a full and more convincing economic revival still rests on improving domestic demand.

This is expected to have an impact on the value of the rand as Chinese demand for South African exports will be affected. 

However, the impact may not be as severe as before, as the formation of the GNU has boosted local assets and the rand. 

“It is notable that South African investments have held up relatively well. Usually, South African assets are “high beta” to global markets, meaning they fall by more in times of stress,” Old Mutual Wealth investment strategist Izak Odendaal said. 

“The rand, in particular, is basically flat against the dollar in 2024, almost unheard of in a time of global market anxiety.”

Odendaal explained that South African government bond yields have also declined because the credit risk premium on bonds has been lower since the formation of the GNU and its commitment to sensible economic policy. 

This means that local assets are in a fundamentally stronger place than they were prior to the GNU, meaning they are unlikely to fall as sharply as they would have previously.