Global banking group Barclays is expecting the rand to strengthen again to below R6 a dollar in the coming months and bond yields to recover on the back of continued strong commodity prices, low inflation and lower interest rates in 2005, according to a recent research report by Barclays Capital.
In its Global Emerging Market Drivers report, released on Wednesday, Barclays Capital writes that it is forecasting South African economic growth of nearly 4% year-on-year in 2005, even as exporters continue to bear the burden of the strong rand.
With inflation continuing to surprise on the downside and inflation expectations moderating, the inflation environment by mid-year looks favourable, with CPIX (headline consumer inflation less mortgage costs) seen between 3% and 3,5% by mid-year, even considering rand and oil price risks.
“South Africa’s balance of payments remains the largest wild card, not directly due to the deterioration of the current account (which could rise to 3% of GDP this year from an estimated 2,5% of GDP [gross domestic product] in 2004), but instead as a consequence of developments on the financial account,” the group cautions.
“Unrecorded financial transactions provided over half the financing over Q1-Q3 last year (and more than 75% of Q3 financing alone).
“Are these hot money inflows attracted to South Africa as a carry trade and, therefore, susceptible to a sharp reversal? If so, this would prove an important risk for the currency and, through rand depreciation, the inflation and growth outlooks.”
However, it notes, should the inflows prove to emanate from domestic capital repatriation, this would be more benign for the rand going forward.
This could mean that a current account deficit of 3% of GDP could leave the rand untroubled, especially given the potential for large inward foreign direct investment into the country in 2005.
According to Barclays, low inflation in the country supports further interest-rate cuts (on the order of 50 basis points) by the South African Reserve Bank (SARB) in 2005; however, timing of the cuts remains uncertain given the recent spate of rand volatility.
“We remain sceptical that the recent weakness signals the start of a depreciating trend for the rand,” the bank writes. “Our macro modelling provides strong support for the argument that the rand trades as a commodity currency.
“Sharp increases in commodity prices…should continue to support the rand going forward, and over the coming months we see the rand trading stronger than R6 per United States dollar, weakening only towards year-end on a gradual relaxation of commodity prices.”
In fact, the bank is recommending taking short dollar-rand positions, with a target for the rand of R5,90 per dollar from the March 23 level of R6,23 per dollar. Recent rand weakness was more a reflection of core market volatility than a change in the underlying rand story, it believes, especially given the strong commodity price outlook.
At the same time, it added, recent market volatility means that the SARB is likely to leave interest rates unchanged in April, therefore supportive of the local currency.
Regarding the local bond market, Barclays says it retains a generally positive outlook in spite of recent volatility. Given the low inflation outlook and its forecast of a further 50 basis-point decrease in the repo rate by the SARB during the year, bond yields across the curve should trend lower.
With the February Budget indicating a sharp drop in domestic funding requirements for fiscal 2005/06, the yield curve is likely to steepen as well, the bank believes, with the spread in the R157-R153 bonds steepening marginally as the yield on the R153 drops toward 7% over the second and third quarters of the year.
“Local funds continue to have relatively little exposure to bonds,” it observes. “Also, the increased desire among international fund managers to get involved with domestic markets means there is a possibility of large demand. Non-resident accounts have been net sellers of domestic bonds since 2000.” — I-Net Bridge