SHORT TERM (THREE MONTHS): The rand saw some weakness when the South African Reserve Bank (SARB) left interest rates unchanged at its January Monetary Policy Committee meeting, which was intensified by the president’s State of the Nation Address being negatively perceived by the financial markets, and the knee-jerk reaction to the announcement of exchange control relaxation in the Budget.

The rand has since strengthened, as expected, as exchange control relaxation contributes to longer-term currency stability, if not strength. The rand may also have been negatively affected by the upward revision of government’s current account deficit forecasts given in the Budget, although they are close to our own. With the United States’ real interest rates now negative, South Africa would likely experience rand strength if the SARB hiked interest rates again, benefiting from increased carry trade activity.

Further, significant rand weakness would push inflation well beyond its expected peak of 10.0% year-on-year. The rand is subject to seasonality, weakening typically in the middle two quarters of the year as investors re-jig portfolios ahead of the Northern Hemisphere summer break and risk aversion levels rise, although this seasonal rebalancing of portfolios may have already taken place over the last couple of months in reaction to the sub-prime fallout.

MEDIUM TERM (SIX TO NINE MONTHS): We believe a budget deficit could easily re-emerge in the next few years, due to the vast spending requirements to bolster South Africa’s infrastructure, growing (and still unmet) socio-economic requirements and possibly even future changes in spending imperatives given the change in leadership of the African National Congress.

South Africa is not expected to run a current account surplus over the next 10 years either. The low level of domestic savings and scale of the infrastructure programmes involved will likely push the current account deficit toward 10% of gross domestic product. Strong inflows on the capital account have financed SA’s growing current account deficit to date and are expected to continue to do so in the future.

However, a sharp rise in risk aversion levels, which results in portfolio disinvestment from South Africa, could cause the rand to be at significant risk (particularly as we cannot rely on foreign fixed investment to any considerable degree to support the rand, not least because of our unreliable and inadequate electricity supply – a likely ongoing situation over the next 10 years).

LONG TERM: Longer-term, the rand is expected to depreciate by the inflation differential between South Africa and its chief trading partners, plus a risk premium. The SARB is likely to continue its policy of purchasing US dollars to build up its foreign exchange reserves when the prevailing exchange rates provide an environment that is opportune to do so.