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South Africa's Rand is a commodity currency, thus the global growth outlook and commodity cycle will typically be principle cyclical drivers of the currency. The Rand is also the emerging market's currency. Particularly during periods of high stress in the global financial market, it will tend to move up and down with fluctuations in risk appetite.
What we have seen recently is increasing domestic risks, starting with sharply widening current account deficit, which hit 6.4 per cent of GDP in the second quarter, and indications that pressure is still on. We also have a sizeable fiscal deficit. We have fairly substantial trade deficit, and to some extent the pressure that have being brought on the Rand is an external and fiscal financing requirement issued. Obviously, when there is very large deficit in a current account, it does not take reversal inflows to pull the Rand weaker, it simply needs for flows to subside and to force some pricing adjustment in the exchange rate.
A big event for the currency was the Moody's downgrade that has occurred recently. It was not such a shock to the market, and it was not really surprising to us. However, the timing of that was particularly unfortunate. It occurred 24 hours before the official deadline for inclusion of government bonds in the World Government Bond Index. I think, the market had been positioned for one-way traffic into that event, but certainly with all the positioning in place the concern would have been that what had looked to be one way traffic suddenly became two-way traffic. The statement accompanying the recent downgrade seems to indicate that Moody's wanted some sort of clarity on a strategic direction and policy out of the conference at the end of this year and also some sort of decisive action. It is not clear to us whether we will get that clarity.
It is combination of all of these things that are driving this weakness at the moment.
How would you evaluate the current performance of the Rand performance?
I think that underlying causes of the currency weakness are fundamental, but into this dramatic type of sell-off, I think, the technicals, in that I would include investors positioning and market sentiment, are really going to determine when the Rand is going to grow. Unfortunately, technical or otherwise, this scale of adjustment (assuming a fair portion of the weakness lasts) also does past a certain point start to have fundamental knock-on effects, which have the potential to undermine the currency and the environment for local financial assets further over the medium term. In particular what I would be concerned about is possible inflationary consequences. Being a commodity currency typically, the Rand has been driven by international variables, international drivers. You would normally give a compensating adjustment to commodity prices, which would diminish the inflationary impact of weakening in the currency, but when it is on domestic, specific fact is that it is not that compensating. Thus, it is somewhat more dangerous for inflation. Given that we have got international oil prices and grain prices at really high levels now, we were really anticipating some adverse impact of exogenous forces on domestic inflation in the middle of this year.
As to the SARB, the central bank is less likely in the near term to cut interest rates. There have been a fair amount of speculations in the market as some analysts expect the central bank to take rates down in November. However, we anticipate a cut later than November.
What is your forecast for USD/ZAR for the year end? What will be the main issues that market participants should focus on?
The Rand is in the middle of trying to find another range somewhat weaker than we have seen over the year so far. My opinion at this stage is the Rand is likely to test the USDZAR 9.00 in the sort-term. The next technical level is 9.2155. For the extended period we have had a view that the Rand would be at around 8.7500. We should expect considerable volatility of aggressive swings around that moderately depreciating trajectory over 6-month horizon.