South Africa’s Sins Forgotten as Rand Leads Post-Brexit Rally

South Africa, Capital Markets in Africa: The currency that was forecast to perform the worst in emerging markets this year is also the one benefiting most from the clamor to boost returns in the wake of the U.K.’s Brexit vote.

South Africa’s rand has strengthened 4.9 percent against the dollar since the day before the U.K. voted to leave the European Union on June 23, the most among 31 major and developing-nation currencies tracked by Bloomberg and bringing gains this year to 11 percent, trailing only Brazil’s real and the yen. Yet analysts still see the currency giving up those gains through the rest of the year.

The odds are stacked against the rand. Africa’s most-industrialized economycontracted in the first quarter amid a slump in commodity prices and the worst drought on record, and the country may have its credit-rating downgraded to junk in December. A municipal election on Wednesday is adding to political risks after President Jacob Zuma roiled markets in December by firing a respected finance minister. For now, that hasn’t deterred the wall of money seeking returns as developed-nation policy makers keep interest rates low to stimulate their economies.

“Investors are not paying attention to the underlying fundamentals or the possible risks but just diving head-first into the pursuit of returns,” said Peter Rosenstreich, head of market strategy at Swissquote Bank SA in Gland, Switzerland, whose strategy is to “invest with the markets.” “It’s whitewashing a lot of emerging-market sins.”

Reduced bets for U.S. rate increases and prospects for more stimulus in Europe, the U.K. and Asia are spurring demand for higher-yielding assets. Foreign investors bought a net 9.1 billion rand ($653 million) of South African bonds in July, bringing inflows this year to 50.2 billion rand, compared with 13 billion rand in the same period in 2015, helping to prop up the currency.

South Africa’s central bank has raised its policy rate twice this year to 7 percent, offering attractive returns for investors who borrow dollars to buy higher-yielding currencies. The rand returned 6.7 percent for carry-trade investors in July, more than double that of the next-best currency, the South Korean won, data compiled by Bloomberg shows.

‘Most Liquid’
“It’s mainly about the carry trade,” said Piotr Matys, a currency strategist at Rabobank in London. “The rand is one of the most liquid currencies and one of the highest yielders. Such a combination makes it very attractive in the current ultra-low-yields global environment.”

The rand’s 25 percent plunge against the dollar last year helped boost exports, with a record monthly trade surplus in May followed by another higher-than-expected positive balance in June. The manufacturing purchasing managers’ index, which fell to a five-year low in December, has been above the 50 level that indicates expansion for five straight months through June, while inflation has slowed from a seven-year high in February.

Still, the longer-term outlook is gloomy. The South African Reserve Bankforecasts zero percent growth this year, while the International Monetary Fund predicts expansion of just 0.1 percent, the slowest since the 2009 recession and not nearly enough to make a dent in the unemployment rate of 27 percent. S&P Global Ratings cut its assessment of South Africa’s debt to its lowest investment-grade level last year, with a negative outlook, while Fitch Ratings also has the nation just one step above junk.

The rand weakened 0.2 percent to 13.9451 per dollar by 12:16 p.m. in Johannesburg, retreating from an eight-month high on June 29.

Fresh Risks
Nationwide local-government elections, seen as a barometer of support for the ruling African National Congress, are creating fresh risks. ANC losses could fuel calls for Zuma, 72, to be ousted before his current presidential term ends in 2019. He’s faced demands to quit since the nation’s top court ruled in March that he violated the constitution by refusing to repay taxpayer money spent on upgrading his private home. Opposition gains may also force the ANC to rethink its policies, such as plans to cut the budget deficit.

Those concerns are relatively benign compared with those in countries such as Turkey, where President Tayyip Erdogan is cracking down on political opponents following a failed coup, according to Medley Global Advisers LLC.

“The market implications will probably be fairly modest in the near term,” said Nigel Rendell, a London-based senior emerging-markets analyst at Medley. “South Africa is still a relatively attractive investment, largely because the rest of the world is so unattractive. It’s probably still worth going for it.”