Two recent events have increased investors’ nervousness about South Africa’s upcoming elections: fresh poll data predicting steeper than expected losses for the ANC and bigger gains for former president Jacob Zuma’s MK Party, and Zuma’s win of an appeal before the electoral court, which allows him to stand as a parliamentary candidate.
The rand weakened by 20c last Wednesday — from R18.44/$ to R18.64/$ — after the Social Research Foundation (SRF) poll showed the ANC may get only 37% of the vote, with the MK at 13%, the EFF at 11% and the IFP at 5%. A very poor showing for the ANC would increase the odds of it forming a governing coalition with the EFF or MK, or both.
Though the rand had recovered within the hour (before being hammered again later by buoyant US inflation data), its latest wobble gives a taste of the extra volatility that can be expected as the May 29 election nears.
While BNP Paribas analysts Nic Borain and Jeff Schultz have little confidence in the SRF poll, it has weakened their conviction in their base case, in which the ANC (winning about 44% of the vote) forms a benign coalition with the IFP.
They now attach a 45% probability to an ANC-IFP tie-up and a 35% probability to the ANC, if its vote share falls to the low 40s, choosing to form a “government of national unity” with the DA, the IFP and the rest of the multiparty charter rather than selecting the divisive EFF as its coalition partner.
They attach only a 10% probability to an ANC-EFF coalition and just a 5% probability to an ANC-EFF-MK tie-up, assuming that most ANC members regard Zuma’s MK defection as a betrayal of the liberation movement.
According to Borain, many private investors and business owners view the radical populist EFF “as something of an existential threat” and as “the worst possible” election outcome. Even the senior ANC leaders canvassed by BNP concede that the party’s alliances with the EFF in Gauteng have been “disastrous” and that such a coalition at a national level would precipitate skills and capital flight.
Krutham MD Peter Attard Montalto also dismisses an ANC-EFF coalition as “a deep tail risk”. He assigns just a 6% probability to this outcome, mainly because he believes the ANC at its core is quite conservative. And even if such a coalition were to transpire, he sees only a 5% probability of the ANC handing the EFF the post of finance minister, which it patently covets.
“The EFF understands the huge power of the National Treasury throughout government, so sees it as a key area to control, [the aim being] to clear out the existing management and weaken its internal structures and culture,” he says.
But with no-one in the ANC backing the idea of an EFF finance minister for fear it would roil the markets, he feels the EFF would be forced to play the long game were it ever to get a seat at the top table, rather than try to “blow everything up” at once.
Even so, if the election did result in an ANC-EFF coalition, he believes the country would experience “a brutal initial shock”, with the rand potentially spiking as high as R27.50/$ “because Pandora’s Box is open; a party that is a coalition between the corrupt and communists has its hands on the levers”.
The rand would likely pull back to about R25/$, he adds, and then glide lower, because at these levels local fund managers are likely to have to reduce their offshore exposure (bring rands home) to stay within the country’s 45% offshore prudential limit — a move which would help put a floor under the rand.
Even so, he predicts that bank lending would dry up and locals would move to cash and try to move money offshore. He suggests that there would be a frantic selling of bonds and equities as confidence collapsed. The capital-outflow shock and tightening of bank lending would push the country into a steep recession while the Reserve Bank would likely be forced to respond to the rand’s nose-dive by hiking rates, thereby deepening South Africa’s economic misery.
If reform momentum (including fiscal consolidation) and economic growth stall, chances are we will be marching towards an unwanted fiscal endgame
— Arthur Kamp
Sanlam Investments chief economist Arthur Kamp says the key issue for market participants, should support for the ANC fall too far, is whether the new government would institute a meaningful change in the direction of fiscal policy.
“The portfolio of minister of finance is critical,” he says. “So, too, is support from the presidency and the cabinet for the fiscal consolidation path. Equally important is that the economic reform drive under Operation Vulindlela continues, as it is key to lifting potential growth, without which the country’s fiscal maths won’t add up.”
The consensus (and Kamp’s own view) is that policy continuity will prevail after the election, allowing economic growth to firm over the medium term as economic reform gains momentum and — crucially — that foreign investors will support this process by continuing to invest in local assets.
The base case of Borain and Schultz (that of an ANC-IFP coalition) is an equally benign view, in that they believe it would lead to a second term for President Cyril Ramaphosa, which he would use to accelerate the deregulation of the logistics network and other pro-growth economic reforms with the help of private investment.
“We have assumed that this would be his imperative, as going for growth appears to be the only way of reversing the trend of declining ANC electoral support that might cause it to lose control of the government in 2029,” explains Borain.
However, if market participants think fiscal consolidation will flounder under a new regime, Kamp expects it would cause a sharp sell-off in both government bonds and the rand, similar to what occurred at the end of 2015 when Nhlanhla Nene was replaced as minister of finance. Only once Pravin Gordhan had been appointed as finance minister did the markets settle.
“If reform momentum (including fiscal consolidation) and economic growth stall, chances are we will be marching towards an unwanted fiscal endgame,” he says.
An ANC-EFF coalition would spell doomsday for the South African economy
— What it means:
The speed at which the country could come undone is difficult to predict. There are a number of levers policymakers could pull to postpone the final reckoning, including prescribed asset regulation and pressuring the Reserve Bank to extend the use of its balance sheet to fund the government. It is therefore critical for the Bank to retain a highly credible governor and for its current mandate to remain unchanged.
Investors’ nervousness over these doomsday scenarios is starting to be reflected in market positioning, according to Schultz, who believes the vote may well wobble the rand as it did in the period around the ANC’s 54th national conference in December 2017.
Though the rand spot price doesn’t yet reflect a significant election-related risk premium, with the currency still being predominantly driven by global factors (especially the recent rally in metals prices), Schultz notes that the market is becoming well hedged for the risk of a more volatile and weaker rand/dollar spot price after the elections.
Heightened political uncertainty is also beginning to be reflected in local rates, he says, as implied by the recent rise in government bond back-end asset swap spreads. When adjusted for funding conditions, they have been consistently increasing since late February (when the election date was announced) and are now at the highest level observed since 2016.
Absa currency strategist Mike Keenan’s base case is for the rand to be trading at R18/$ by midyear and at R17.50/$ by year-end. This assumes a benign election outcome that results in broad policy continuity.
Though he concedes the rand could briefly spike above R20/$ after the elections, he doesn’t believe it could sustain such weak levels, because South Africa’s prudential limits would then kick in.
He notes, for instance, that during the Lady R saga last year, when South Africa was accused of selling arms to Russia, the rand ran rapidly to just over R20/$ but then came screeching back again. Keenan attributes this to the impact of prudential limits.
“We’re not disputing that this is a very different election, and we aren’t ruling out the possibility of a more volatile market reaction this time, but we like to focus on there now being a lot more mitigating factors tilting in the rand’s favour,” he says.
These include that load-shedding has eased, global risk appetite remains supportive and commodity prices are firming because the US economy is proving so resilient. The rand is also looking relatively cheap compared with other emerging-market and commodity currencies, which means that quite a bit of uncertainty is already priced in.
In fact, Absa is telling clients, especially importers, not to react to huge rand/dollar spikes should they occur, or to assume that, if there is a run on the rand, it will just keep weakening.
“For that to happen there would have to be a complete paradigm shift, totally new thinking, like a change in capital controls,” says Keenan, “but at this stage it’s all just mere conjecture. We will have to wait for the facts to present themselves.”
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