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What to consider before the budget speech

AS the curtains rise on the economic stage of South Africa, all eyes turn to the 2024 budget speech set to be held on February 21, 2024. Against ongoing domestic challenges and into an election year, this address will be as intriguing as ever, with stakeholders eagerly awaiting signals on taxation, government expenditure allocations and policy reforms.

The budget speech holds significant implications for any investor interested in the South African landscape. This article delves into some factors affecting the rand and its performance.

Budget speech and February seasonality

Over the last five years, there have been three instances where the rand weakened in the month leading up to the budget speech. Specifically, in 2019, the rand depreciated by 5,9 percent after then-finance minister Tito Mboweni announced an unexpected widening of the budget deficit. In February 2020, the currency saw a 4 percent decline following Moody’s warning about risks associated with the budget projections. Furthermore, the rand experienced a 5,2 percent fall against the dollar last year, primarily due to apprehensions surrounding the R254 billion bailout intended for Eskom.

On average, the rand experienced a 2,9 percent depreciation in February, in contrast to a 1 percent average loss observed in the Emerging Market Index during the same timeframe. This pattern suggests a significant correlation between the annual budget speech and the early-year performance of the rand.

Longer term view

The budget speech provides insightful perspectives on the rand’s immediate performance. Still, it’s equally important to examine its trajectory from a long-term perspective, focusing on the factors influencing its future direction.

In this context, it’s noteworthy that the rand has experienced significant depreciation against the major currencies of developed nations

Several factors have contributed to the rand’s depreciation, perhaps the most significant being the persistent challenge of load shedding. This issue has significantly hindered the growth of South Africa’s economy. Notably, 2023 marked Eskom’s most challenging year for load shedding, with the country experiencing power outages for approximately 20 percent of the year. This equates to 72,6 days, or 1 742 hours, without electricity.

The electricity crisis escalates company expenses and diminishes production, resulting in more business shutdowns and layoffs. This sequence of events contributes to a rising unemployment rate, reducing the tax base.

This situation forces the government to increase social grant payments, reducing the funds available for infrastructure projects to address the electricity crisis.

When you also consider the operational and financial challenges faced by another state-owned entity, Transnet, it appears that the economic difficulties in South Africa are likely to persist.

Other economic challenges that South Africa faces are:

◆ Unemployment crisis: Official unemployment rate of 31,9 percent and 41,2 percent expanded unemployment rate in South Africa as of Q3 2023 (Stats SA, 2023)

◆ Tax base and government grant payments: Only 10,8 percent of South African individuals are expected to pay income tax for the 22/23 tax year (Sars, 2023), while in December 2021, 47 percent of the population were

receiving grant payments (Sassa, 2023) ◆ South Africa greylisting by the Financial Action Task Force (FATF): Increased monitoring of investor source of funds and enhanced due diligence.

These ongoing challenges have contributed to the rand’s dramatic depreciation of 173 percent against the US dollar over the past 20 years. It’s important to note that this decline is not solely due to the strength of the US dollar; during the same period, the rand has also depreciated by 130 percent against the euro and 86 percent against the British pound.

External factors, such as economic activities in countries like China, the largest importer of South African commodities, also influence the rand’s performance.

The recent slowdown in China’s economy, attributed to its real estate market slump and a global decrease in demand for its manufactured goods, has had a significant ripple effect on South Africa due to the close economic ties between the two nations. While China’s economic challenges can be partly attributed to the pandemic and relatively slower inflation compared to the global average, South Africa faces its unique set of problems compounded by the repercussions of China’s economic downturn.

General emerging markets

The underperformance of emerging markets (EM) compared to developed markets in recent years has been widely acknowledged. Factors such as a robust US dollar, geopolitical tensions, underwhelming earnings growth, and a diminishing economic growth premium relative to developed markets have significantly influenced sentiment.

There is a lot of talk surrounding a possible recession in the US, but how does that affect an emerging market like South Africa? The truth is that emerging markets generally do not have the high level of market efficiency that a developed market does; they also tend to have additional risks compared to developed markets, which can include political instability and currency volatility and may not have as liquid markets. But with all this additional risk comes greater potential returns.

With subdued valuations, a declining US dollar, inflation reaching its peak in numerous emerging market nations, and the prospect of interest rate reductions, the initial phases of recovery are coming together.

Conclusion

As South Africa’s economic performance continues to lag, the argument for diversifying into hard currencies becomes increasingly compelling. Investors who opted for a USD cash account over the last five and 10 years saw their investments in rand terms grow by 38,53 percent and 70,98 percent, respectively, without facing any risk to their capital.

In contrast, the JSE All Share delivered lower cumulative returns of 37,28 percent over five years and 61,70 percent over 10 years, experiencing significant fluctuations during these periods, such as in 2020, when the JSE plunged by -27,64 percent. This stark contrast underlines the advantages of hard currency diversification, considering the ongoing economic difficulties in South Africa.

At Paragon Wealth Managers, we acknowledge the complexity of managing rand volatility and recognise the need for a holistic approach.

Successfully navigating this volatility involves conducting thorough research, implementing diversification strategies, and seeking professional advice, particularly when exploring long-term investment prospects.

Our approach centres on diversifying our clients’ overall wealth across local and international assets, a prudent measure aimed at minimising the impact of rand volatility on personal wealth. — Bloomberg