FxWirePro: South Africa's downgrade rating hopes to weigh on treasury and ZAR

The South African rand recovered marginally today, with USDZAR dropping back to levels around 14.3632 after the cross had gained significantly since Yesterday and temporarily exceeded the 14.55 threshold on Monday.

In addition to weak production data and negative news about the financial situation of some state-owned companies – in this case, electricity utility Eskom – internal pressure came above all from rumors about Zuma considering the abolition of student fees. However, with the budget deficit wide anyway, it is unclear how the resulting just over ZAR50bn in lost revenues can be financed.

As a measure of protest, Michael Sachs, Head of the National Treasury’s Budget Office announced his resignation. Investors fear a further erosion of public finances as a result of the government leaving its consolidation path.

This could trigger further downgrades in the next rating round on 24 November 2017. The Treasury tested the market carefully in advance, launching a ZAR bond auction totaling ZAR3.3bn yesterday.

Thanks to the relatively high coupon and the weaker rand, it was received well. Whether the risk premiums will be worthwhile for investors remains to be seen. The rand is likely to remain volatile and under pressure in coming weeks, not only as a result of the forthcoming rating reviews and imminent party convention in December.

Thus, staying shorts in ZAR vs a 50:50 USD:EUR basket is advocated. We continue to believe sovereign rating downgrades are an imminent risk to ZAR and expect further hedging demand and outflows in preparation for the event.

We also continue to believe a market-unfriendly outcome is more likely out of the December ANC elective conference.