The rand hits record low on Russian arms accusation

The rand, bonds and domestically exposed equities fell sharply yesterday following US ambassador, Reuben Brigety’s assertion that South Africa supplied Russia with weapons and ammunition when a Russian ship, the Lady R, docked in Simon’s Town late last year.

The confidence expressed by the ambassador regarding the veracity of the accusation is very concerning. The US is our second largest trading partner and although South Africa is not precluded from selling arms to Russia, such an action dramatically increases the risk of reprisals from the world’s largest economy. Most at threat is the duty-free access into the US through the AGOA trade deal, putting as much as R400 billion of trade at risk.

Following the ambassador’s press conference, Cyril Ramaphosa announced the establishment of a judicial commission of inquiry to be led by a retired judge to investigate the allegation. This is despite US officials having raised the issue through diplomatic channels over the last month, with the South African delegation already promising an inquiry into the allegations. The latest knock compounds an already dour near-term outlook for the country. The rand (and most of the world’s currencies) have been on the backfoot since the US Federal Reserve began its aggressive interest rate hiking cycle at the start of 2022. Year-to-date, most currencies have strengthened against the dollar as monetary policies have converged. The rand has not seen nearly the same benefit as the power crisis and now the severe souring of diplomatic relations with the US have resulted in the rand hitting an all-time low against the dollar.

The severity of the allegation should not be taken lightly. However, we would also caution against any knee-jerk reactions. The last eight years have been tumultuous for South African investors and the country continues to shoot itself in the foot during a time that has been generally unkind to emerging markets in general. In December 2015, we experienced a similar idiosyncratic weakening of the rand after Jacob Zuma fired Nhlanhla Nene as Finance Minister. 

The biggest known risk we face is undoubtedly insufficient power generation capacity, particularly through the more power intensive winter months ahead. Based on recent power plant performance, the prospect of higher loadshedding stages over the next few months is all but certain.

We do, however, expect the intensity of loadshedding to peak over the winter months and steadily improve thereafter. This optimism in no way relates to government’s ability to turn the situation around but instead stems from private sector intervention. The opening up of private sector power generation by removing the requirement of applying for generation licenses for any plants larger than one megawatt, will effectively lead to privatization by stealth.

We have seen some encouraging leading indicators recently:

• Imports of solar panels from China amounted to R2 billion in March – more than whole of 2018.
• Around 2.5 GW of renewable projects were registered with the government regulator in the first quarter of this year – more than the previous three years combined.
• There are 13 GW of renewable projects at pre-registration stage, with around 60% of that representing corporate power purchase agreements (PPAs) rather than grid supply projects dependent on Eskom.
• Vestas Wind Systems, the world’s largest onshore wind turbine manufacturer, cited South Africa and Brazil as the two countries from which it took the highest orders in the first quarter.

South Africa’s neutrality during the duration of the war in Ukraine has been embarrassing but hasn’t threatened existing trade deals. Being seen as actively supporting the sanctioned Russian regime pushes relations into dangerous territory. Holding our relationship with an Apartheid-era “comrade” above the economic reality of trade significance risks heaping even greater pressure on the country, at its weakest moment. In the short-term, the rand could well weaken further, but based on fundamentals alone, the rand is very undervalued at current levels. The currency has a history of overshooting to both the upside and downside and we see this reaction as being another example of that.