Real Estate Investor Magazine South Africa Real Estate Investor Magazine - April 2017 | Page 57

USD -ZAR valuation
Red: PPP rate | Yellow: IRP rate | Gray: Actual rate | Green: IRP & PPP combined
To determine this, we need to look at whether the Rand
is over- or under-valued. Currently, market analysts feel
that the Rand is close to being correctly valued after
taking economic theory into account.
How will the Rand behave?
Looking back from 1994 to now, we have used two
popular measures to assist us with a forecast. Purchase
Power Parity (PPP) and Interest Rate Parity (IRP) are
economic models that are often used when looking to
determine future currency performance in the medium
to long term.
Although the formulas are fundamentally sound,
we know too well that economic theory and real world
application are two different things. They seem to
provide us with a decent outlook as to where the Rand
should be trading, roughly.
At the time of writing, the Rand was trading at 12.78
to the dollar. According to the graph above this placed
the Rand slightly higher than the 12.87 the combined
IRP & PPP predicts. This is to say that the Rand is still
somewhat undervalued to the USD and there may be
some residual “risk premium” priced in. Unfortunately,
for emerging markets, this premium is present more
often than not, due to the nature of their sovereign,
political and economic risks.
Learning from Brazil’s Real
From August 2014 until February 2016 Brazil was
downgraded three times each by S&P, Moody’s and
Fitch. Over the course of that period we saw the
Brazilian Real weaken by 76%, from 2.27 to 4 against
the USD.
This effect was largely overstated and I am pleased to
report that the BRL has since recovered by 28% from
www.reimag.co.za
its lowest point. This confirms that in the period leading
up to the expected downgrade, markets could overstate
the expected effect due to fear of the unknown.
What happens to South Africa’s government
debt?
In the event of a downgrade, currencies often take a
hammering, but while this happens bond yields will
rise. This may sound like a good thing but it’s not,
as yields are inversely correlated to price. Foreign
investors will be offloading local bonds partly to avoid
any possible risk and to prevent possible exchange rate
losses.
Ultimately this means our government’s debt (bonds)
lose their coveted “investment” grade status. Many
global bond Indices will remove South African bonds
from their tracking. This then prompts global investors,
both institutional & individual to sell South African
bonds (if they are using Indexes to manage their funds).
Currently, we are included in the Bloomberg USD
Investment Grade Emerging Market Bond Index and
the World Government Bond Index. Should both two
of the three agencies downgrade South Africa, we
could find ourselves falling off these Indexes.
In addition, one also has to take into account that many
Global pension funds are prohibited from investing in
“junk” debt. This will all contribute to a massive flow of
money out of the Republic.
How will the SARB intervene?
In the days following the downgrade, the market will
look to the Reserve Bank for a response. The most
expected reaction will be for them to raise interest rates.
This should encourage capital inflow that is expected to
bring exchange rates back under control.
APRIL 2017 SA Real Estate Investor
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