Farmers’ expertise lies in the production of agricultural commodities, but the exchange rate is critical to farmers’ profitability. South Africa has one of the most volatile exchange rates in the world, for a complicated variety of reasons, which adds to the risk faced by agricultural producers in South Africa’s risky environmental situation, with unpredictable rainfall.
The rand has weakened by around 28% against the US dollar this year, hitting a peak of R19.35 per dollar at the start of April, before rallying somewhat to R18.45 to the greenback. This rand weakness has come on the back of heightened global risk aversion associated with the Covid-19 pandemic, as well as substantial outflows from the South African bond and equity markets, with bond outflows due in part to South Africa’s sovereign credit rating downgrades from both Moody’s and Fitch and SA’s exclusion from the World Government Bond Index (WGBI) at the end of April.
However, we expect the rand to recover in the latter half of the year for the following reasons, assuming that South Africa is able to get on top of the Covid-19 pandemic and to some extent reboot its economy after the lockdown measures:
A number of local asset managers are above their prudential offshore investment allowances as a result of this year’s rand weakness and a likely sharper sell-off of domestic markets compared to international markets, and their consequent need to repatriate some of their offshore investments over the coming months.
We believe that from a purchasing power parity perspective, the trade-weighted rand is currently 17% undervalued, while our peer model (which calculates the implied fair value of the rand based on other high-yielding and commodity-based currencies) suggests that the rand should currently be trading at R16.98 to the dollar.
Current account balance
We expect the current account deficit to narrow significantly this year due to improvements in South Africa’s terms-of-trade improvements (essentially the price of its exports versus that of its imports), reduced dividend and interest payments abroad, and import compression due to the weak economy. The slump in the oil price as well as strong precious metal prices underpin sharply better terms of trade over the last year, while aggressive net sales of South African bonds and equities in recent quarters ought to lower coupon and dividend commitments to offshore investors. Absa now forecasts a current account surplus in the first quarter – the first since 2003, and a deficit of just 0.9% for 2020 as a whole. A smaller current account deficit reduces the need for a more competitive exchange rate.
We believe the South African Reserve Bank is unlikely to cut policy rates to the extent that is currently been priced into the market, which together with a reduction in global volatility levels should enhance the rand’s carry trade appeal.
Given the above reasons Absa forecasts the rand to be R18.00 to the greenback by the end of June and at R16.40 by year-end.
Risks to our view
Firstly, global investors are generally risk averse. Any fresh wave of global risk aversion due to the heightened USA/China trade war tensions or Covid-19 related fears could keep the rand weaker for longer. For instance, the Trump administration may want to retaliate against China in response to the global pandemic outbreak that originates in the city of Wuhan. One way of accomplishing this is to increase tariffs on Chinese imports to the USA even more.
Secondly, with the South African government aiming to borrow up to $4.2 billion from the IMF and $1 billion from the New Development Bank, the rand could begin to recover more quickly than expected if these loan deals are quickly agreed and the National Treasury converts this multilateral funding into rand in the next couple of months.
Due to our open economy, the value of the rand plays a very important part in the returns a producer realises by the end of the export season. It is not only true for producers that export. The value of the rand determines the majority of our local agricultural product prices, not to mention the prices of production inputs. The successful management of a producer’s forex account and exposure to volatile exchange rates can optimise his efforts to limit income risk and to earn what he deserves for his effort to ensure food security to the nation. Producers may need to talk to their financiers on a more frequent basis and get the necessary forex support to optimise their profits.
Michael Keenan, Peter Worthington & Wessel Lemmer, Absa Research and Agribusiness.