Financial

RMB sees “significant chance” of rand blow-out

By most accounts, the rand is undervalued and holding amazingly steady in stormy waters. There are however also warning lights flashing.

Speculating where the rand is headed is a notoriously treacherous terrain, but Rand Merchant Bank have ventured where angels fear to tread, predicting there is a "significant chance" the rand will see the wrong end of nine to the dollar this year.

The bearish call is a contrarian view with the consensus forecast now estimating that the rand will end the year at around R8/$. It is also a step outside of the rand's current trading range of between R7,50 and R8,22.

But in a lengthy report, RMB currency analyst John Cairns warns of the possibility of a "blow out" against all major currencies, although his most probable prediction is that the rand will decline to R8,50 by the end of the year.

Cairns concedes that the rand is undervalued about 15% on a purchasing price parity basis, and also that the current-account deficit should gradually improve during the year.

His argument is hinged on the "shocking state" of the balance of payments. At the same time, the usual array of countervailing forces, like portfolio inflows and fixed direct investment, that have up to now served to finance this deficit are drying up.

The "massive" 9% of GDP 1Q08 current-account deficit didn't shock the market. But he said "it is a terrible number nonetheless, implying an annual funding requirement of close to R200bn".

Yet, the deficit should improve and this number could end up being the worst in the current cycle.

Higher commodity prices, the lagged effect of past rand weakness and most importantly a slowdown in domestic spending will contract the trade account.

 But payment outflows on the country's accumulated debt continue to grow and so any recovery in the overall current account will be slow.

"We now look for a 7,8% deficit this year and the problem remains in funding it." In the first quarter, SA was saved by the Standard Bank (JSE:SBK) deal while large bond inflows in April funded the deficit in Q2.

"But what about Q3 and onwards? Certainly, there is no evidence of a return of portfolio inflows."

Not all economists are so pessimistic. Brait (JSE:BAT) economist Colen Garrow points to the "massive" interest rate differential that has opened up between SA and the US in particular. That interest rate differential, now a ten percentage point difference with the US and 7.5 point difference with the Euro zone, should encourage portfolio inflows.

There is also some recognition that SA is buffered by the fact that commodity prices tend to move in tandem, he said. Consequently, outflows due to the increase in the oil price tend to be balanced by inflows for other commodities.

Yet Garrow also notes certain risks, including the increasing use of the "r" word in developed countries. The prospect of recession tends to encourage a flight to safety, and the rand as the world's second most liquid emerging market currency, does tend to bear the brunt of these movements.

Cairns also notes some potentially positive factors for the rand, including the possibility of a "mega" foreign direct investment deal. "MTN (JSE:MTN) is obviously in the forefront here."

But he adds: "In all, there is a lot of talk and a lot of rumours but nothing substantiated and that we can base a rand view on."

In the absence of the traditional portfolio inflows, and without a big FDI deal, current account funding will rely on short-term flows, Cairns writes.

These comprise local banks taking deposits from abroad and local corporates borrowing from offshore, offset by local banks placing deposits offshore.

Interestingly, he notes that such flows have been growing in importance: their share of total inflows growing from less than 20% in 2004 and 2005, to 40% in 2007 and 70% in 1Q08.

There flows are however volatile. "Local cash has usually been the first to flee during periods of currency stress," he writes.

Print story    Email story

COMMENTS