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South African market volatility to intensify in coming weeks

The rand opened weaker on Monday and stayed relatively depressed Tuesday as market uncertainty increased following reports over the weekend that South Africa’s Finance Minister would be arrested. Analysts say the volatility is likely to intensify in the weeks to come.

May 17, 2016 // 9:24AM

South Africa markets tumbled this week after recent press reports, which have since been denied by President Jacob Zuma, suggested Finance Minister Gordhan along with up to eight other former senior tax officials face imminent arrest for running what is being portrayed as a rogue agency within the revenue service.

The reports come after a period of relative calm in South Africa, which followed a highly volatile period that saw the country appoint three Finance Ministers within the space of 10 days in January.

The rand, which was trading at around 15.3 against the US dollar on Friday, sunk Monday morning to 15.7420 before recovering slightly to 15.65 by close of trading. The yield on benchmark government bonds due in 2026 was up 13 basis points at 9.330% after jumping as much as 17 basis points in early trading Monday.

The rand’s performance was weaker against all of the major currencies by end of trading Monday, losing ground against the pound (1.9%), the euro (1.8%) and the yen (1.2%). The ZAR has so far put in the worst performance among both commodity currencies and EM currencies.

Despite an increase of foreign capital going towards longer-dated South African sovereign bonds in April and the first week of May, analysts anticipate market reaction to political volatility in the country won’t ease anytime soon.

“While SAGBs were under pressure yesterday, chances are that some South African exposure will be hedged via the currency, if only temporarily. We therefore would not be surprised to see the rand more volatile than bonds,” Walter de Wet, a fixed income and foreign exchange strategist at Standard Bank, explained in a briefing note this morning.

“That said, South Africa’s credit risk, as implied by the country’s 5-year USD CDS, has climbed back to 311 bps – which now is only 16 bps below that of Brazil which has a foreign currency rating well below that of South Africa.”

Win Thin, Global Head of Emerging Markets Strategy at New York-based fund managers BBH said if the reports about Gordhan and related rumours that he would be replaced by Eskom CEO Molefe and Deputy Finance Minister Jonas by lawmaker Mangosuthu Buthelezi were true, “it would be an unmitigated disaster for the nation.”

“Fiscal policy is a key concern given the turmoil involving the Finance Ministry. The budget deficit is forecast by the OECD to remain near -4% of GDP in both 2016 and 2017, virtually unchanged from -3.8% in 2015. This is more pessimistic than the path Gordhan set forth in his February budget speech, which saw the deficit narrowing to -3.2% of GDP in fiscal year 2016/17, -2.8% in fiscal year 2017/18, and -2.4% in fiscal year 2018/19.”

“With FDI remaining low, much of this deficit will be financed by hot money, making South Africa one of the most vulnerable nations to swings in global sentiment.”

He explained that with inflation likely to rise and the SARB continuing its tightening cycle, South African bonds will start underperforming more.

Additionally, the risk of a credit downgrade, which could push bond premiums to new highs, still looms. South Africa’s government will meet with officials from Fitch and S&P this week, with both firms expected to release their analyses in June. Both agencies have South Africa at BBB-. While S&P has a negative outlook, Fitch moved the sovereign to a stable outlook after its December downgrade. Moody’s recently confirmed its Baa2 rating but kept the outlook on negative watch.

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