Good news for the rand

The rand recently broke through the R18/USD mark, and while it has weakened slightly since then, the local currency has some significant tailwinds that support its current levels.

Investec chief economist Annabel Bishop said the rand continues to attempt to break through the R18.00/USD mark, a major resistance level, after temporarily reaching R17.99/USD on Friday.

The rand rebounded above R18.00/USD on Friday, and sits at around R18.01/USD on Monday, 19 May.

Bishop explained that this currency strength is largely due to markets anticipating the announcement of a new inflation target for South Africa.

Debates surrounding a change in South Africa’s inflation target have been ongoing for years, with Reserve Bank Governor Lesetja Kganyago being a staunch supporter of a change.

The Reserve Bank currently aims for inflation to fall within a range of 3% to 6%, ideally anchored around the mid-point of this range, 4.5%.

However, this target has been in place since 2000, and the Reserve Bank has been itching to lower it for some time.

Kganyago, in particular, has long advocated for shifting to a lower and single-point target, arguing that this would better position South Africa to compete with its trading partners. 

He previously said a single-point target of 3% would be in line with South Africa’s peers and lead to lower interest rates in the long term.

Bishop explained that the National Treasury would likely prefer a gradual descent, as opposed to the Reserve Bank’s preference of close to 3.0%.

In South Africa, the National Treasury sets the inflation target, while the Reserve Bank is mandated to achieve it. The National Treasury recently indicated that a change is imminent, which saw markets react positively.

However, the National Treasury has also previously warned that the process of achieving a new inflation target will not be painless.

This is why Finance Minister Enoch Godongwana previously asked the National Treasury and the Reserve Bank to determine the full impact on consumers and the economy before any changes are made to the inflation target.

The International Monetary Fund also warned earlier this year that changing the inflation target must be done at the appropriate time to ensure macroeconomic stability and minimise the potential impact on economic growth and employment. 

With the National Treasury and the Reserve Bank seemingly at odds about what the new target should be, Bishop believes a compromise of a new target range of 2% to 5% is possible, which would put the midpoint at 3.5%.

She also warned that a new target midpoint of 3.5% would likely mean no further interest rate cuts for this year. 

This would likely see the rand strengthen towards R17.50/USD as the United States cuts its interest rates, with two 25 basis point cuts currently expected in 2025.

Positive outlook

Another recent tailwind for the rand has been S&P’s country review on Friday, 16 May, which saw the credit rating agency affirm South Africa’s BB- foreign currency rating and BB/B local currency rating, maintaining a positive outlook on the potential for reform.

In its review, S&P noted the potential for stronger growth in South Africa, despite trade- and tariff-related headwinds.

It also saw a strong potential for government debt consolidation if the coalition government can accelerate economic and fiscal reforms while addressing infrastructure pressures.

The firm said it could consider raising the country’s ratings if an improving track record of effective reforms results in stronger economic growth and reduced government debt and contingent liabilities.

“Despite the re-tabling of the budget and the likely removal of VAT, the government plans to continue with fiscal consolidation, and fiscal financing benefits from access to deep domestic markets and an actively traded currency,” the rating firm said.

“Despite the significant disagreements, the coalition government of national unity (GNU) has managed to remain intact, which we believe bodes well for broad policy continuity and enhanced reform momentum.”

The National Treasury has pointed out that the ratings benefit from South Africa’s sizable and sophisticated financial system that provides a deep funding base for the government. 

“The country also has relatively strong institutions, with good checks and balances, particularly its central bank,” the Treasury said.

“The ratings are constrained by relatively low GDP per capita and low GDP growth rates, as well as sizable fiscal deficits and high government debt.” 

However, it said the positive outlook reflects the potential for stronger growth than the National Treasury currently expects.