The uncertainty that surrounds the Federal Reserve’s timing of the first rate increase in a decade (update: eventually happened on December 15, 2015), coupled with China’s current economic headwinds, still poses a downside risk for the ZAR. China has been of considerable economic importance, not just for South Africa’s economy, but for the Global economy. This downturn has caused many major Central Banks to adjust their monetary policy accordingly.
The South African Reserve Bank has been forced to pull back from an ambitious plan to continue the hiking cycle – this following a strong pattern set by other Central Banks. Every country that attempted to hike their rates was ultimately forced to return them to previous levels as their economic outlook worsened.
Concerns about financial stability centered around the health of the global markets and overall GDP global growth, to which China greatly contributes. Questions are now also surrounding whether the Federal Reserve, the ECB or the BOJ will expand their monetary policy to generate growth domestically.
Another risk that threatens Global growth is the extent to which Emerging Market economies are exposed to risk. Despite a strong rebound in their capital markets, we haven’t seen any significant change in the economic fundamentals, with most remaining unimproved, yet positive sentiment remains with analysts predicting stability in the market despite headwinds.
As China is a major export destination for South African goods, now idling with a stalled economic growth rate of 7%, the South Africa Rand remains vulnerable to their economic policy. In addition, China has shifted economic focus toward spurring domestic consumption for growth rather than through international trade. With the Rand being a commodity driven currency, and the sentiment towards commodity market remaining largely negative, the outlook is concerning for South African GDP growth.
Dropping commodity prices are a concern because currencies like the ZAR, which is dependent on commodity exports for forex exchange generation, will rise and fall on commodity price performance. We know that commodities are very important for both the consumer and the producers, but it seems that the pricing is better representing the supply side. This is where, if the commodity price is lower, it is perceived as a risk which in turn will put more downside pressure on the commodity currencies.
While some of the weakness in the ZAR may be caused by the negative Global risk sentiment, domestic developments and the internal affairs are adding to the instability and maintaining downward pressure. The ongoing student protests in South Africa is one example of what is adding to that uncertainty, and ultimately sending a bad message to investors who want a predictable and stable economic environment to invest in. South Africa as an Emerging Market is dependent on this foreign capital investment to generate tax income and jobs.