China is South Africa’s biggest trade partner globally, and thus the SA economy is more sensitive to any headwinds coming from the second largest economy in the world. More than just that, South Africa is also China’s largest trading partner in Africa. According to the global trade statistics, South Africa has imported a total of $13.5 billion in services and goods from China.
Since both China and South Africa are part of the BRICS nations or the five emerging economies, they have much stronger co-operation than with other nations, and these strong ties will impact the South African Rand exchange rate.
Currently, the greatest threat to the Chinese economy is the ongoing trade war between the US and China. The South African economy could suffer considerably if the Chinese economy slowed down. A full-blown trade war between the US and China would slow overall global economic growth and subsequently, this would have negative effects on the South African economy.
We have already seen how the headwinds from the current trade war tensions have impacted the South African Rand, which was hammered to a two-year low as the spillover effects from the Turkish Lira crash has spread on other emerging market currencies. The South African Rand lost more than 10% of its value on the back of the high-risk environment suddenly exposed all emerging markets. This showed us that emerging markets as a whole can contribute to the negative market sentiment.
However, since the South African economy has much closer ties to the Chinese economy, a full-scale trade war scenario between the US and China will have a much bigger impact on the Rand.
Looking at the debt levels, South Africa owes around 40% of its GDP and the impact of higher interest rates, especially in the US would add tremendous pressure on the USD/ZAR exchange rate. South Africa’s GDP growth is expected to only hit a modest 1.7% in 2018, and the Chinese manufacturing activity has slowed down due to the trade wars.
China is also in a long-term process to shift from an investment-driven economic model, towards an economy driven by consumption. South Africa, a commodity-driven economy will feel the impact of the new Chinese economic model because China consumes over 50% of the world’s hard commodities – the kind that South Africa heavily exports to China.
Chinese direct investments into the South African economy also grew at a moderate pace with only a few big investments. China sees the rigid labour market conditions as the main obstacle and the main reason why they are showing restraint in committing to making bigger investments. However, at the most recent BRICS summit held in Johannesburg, we saw new bilateral trade agreements that will encourage the two-way trade volume increase after China pledged to invest more than $40 billion in South Africa economy. Two-way trade between China and South Africa reached R525 billion last year, reflecting the strong economic ties between the two countries, and underlining the importance of this economic relationship.
The USD/ZAR exchange rate will remain subdued in the current economic climate were trade wars right and left are the new norm. Since the markets are interconnected in the global economy, when investors smell risk they often sell the riskier assets such as the Rand. Investors are also risk takers, and they will eventually start chasing yield again once the trade war risk factor fades away.
Remember, the USD/ZAR has reached an all-time high in 2016 at 17.8187 over fears of a slowdown in China’s economy. So, if history is to be taken as a guide, the South African Rand could face more pressure should data show that the Chinese economic growth is slowing.