South African Debt Downgrade to Junk – Flight to Bitcoin?

The South African rand plunged more than 11% in the last 7 days, first rattled by a downgrade by Standard & Poors to junk status as well as the move by Moody’s to place South Africa – which it has two notches above junk – on downgrade review. It lost over 1.5% in the last 12 hours, during which time these actions were taken. By 07:55 am South African time, it was trading at R13.88 to the US Dollar.

The saga started with South African president, Jacob Zuma, sacking popular finance minister, Pravin Gordhan and replacing him with Malusi Gigaba.

As reported in the Guardian:

South Africa’s new finance minister to ‘radically transform’ economy

South Africa’s new finance minister has pledged to “radically transform” his country’s economy, signalling a dramatic swing to the left less than 48 hours after taking up his post.

Malusi Gigaba was appointed after president Jacob Zuma sacked his widely respected predecessor, Pravin Gordhan, in an overnight cabinet purge last week. The move, late on Thursday night, triggered a political crisis, pitching the ruling African National Congress party into chaos.

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What does this mean for ordinary South Africans?

Johannesburg – The downgrade to junk status will trigger a number of economic setbacks, which will impact living standards of South Africans, the Institute of Race Relations (IRR) said in a statement.

“The downgrade greatly complicates the prospects for South Africa being able to stage an economic recovery. Without a growth recovery, employment growth and revenue collection will stagnate and may even decline,” said CEO, Frans Cronje.

This will translate into declining living standards of the poor and middle class in South Africa, he said. “A priority for policy makers must therefore be to take urgent steps to ensure that South Africa does not now move through a destructive cycle of multiple downgrades.” Cronje called for the decision to have Malusi Gigaba appointed finance minister reviewed.

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What does this mean for the South African rand?

 

The chart above shows the exchange rate of the rand against the US Dollar since 1972. The most worrying aspect of this trend is the exponential decline in the rand in recent years.

Currently the rand is facing a perfect storm and RMB currency strategist John Cairns outlined 7 risks that might impact the rand.

1)  Whether Zuma reverses his decision as he did after Nenegate. The presumption must be that this is extremely unlikely: he surely prepared much better this time around and would not have acted unless he was confident he would not have to reverse his decision.

2) Whether the backlash within the ANC and broader society forces Zuma out of office. This also looks unlikely. Zuma has the backing of most members of the ANC’s National Executive Committee, which has the power to recall him. Parliament could pass a no confidence motion, which we understand requires 50%+1 of the vote, but this would require a revolt within and so a break-up of the ANC, which is probably a step too far.

It is not clear when the no confidence motion will be voted on: the Economic Freedom Fighters has requested this to happen between April 7 and 9, but the call sits with the House speaker. Protests on the street are highly likely, but don’t mean much unless they get the NEC or Parliament to act.

3) How rating agencies respond. We think it is very likely that all the agencies will downgrade the sovereign credit rating by one notch each. This means that the foreign currency credit rating from S&P and Fitch will fall to BB+, while it will sit at the edge of investment grade at Moody’s, Baa3.

We think all three rating agencies will retain their negative outlooks. Moody’s action will occur as per schedule on April 7. Fitch is not bound by a timeline so it can also act quickly. It is not certain but S&P might bring forward its review to the coming weeks, ahead of the scheduled June 2 deadline.

4) How foreign investors (as tracked in the daily flows data from the JSE) respond. A key reason why the markets have held up so well over the past week is that local political problems have come against an extremely favourable global backdrop – foreigners have been aggressively buying into all emerging markets.

Foreign flows will indicate which of these two forces – the local negative or the global positive – will dominate going forward. Flows have been remarkably strong so far this week but this might have reflected disbelief that Gordhan would go rather than the view that global issues dominate, and we suspect flows will turn negative today.

5) Comments or actions from the new finance minister –  remember Des van Rooyen made some outrageous statements when he was appointed. New Finance Minister Malusi Gigaba is likely to be circumspect: although in the Zuma camp, he is generally respected for his activities in previous roles.

6) Resignations from the Cabinet. Ministers from the South African Communist Party will surely feel they need to go. The bigger question is whether Deputy President Cyril Ramaphosa also goes. The more people who leave, the more pressure will build on Zuma.

7) Any indications from within ANC structures on how the president’s actions will influence how the elective conference will play out in December.

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Should South African panic?

Maybe it’s time for a short history lesson…

The Hyperinflation of Zimbabwe in 2006

Government reforms and involvement in the Congolese Civil War lead to a slow economic decline for most the early 2000s. The prolonged recession caused citizens to flee the country and led to higher unemployment rates. As Zimbabwe’s government was collecting few taxes while spending money on luxury items, it was running out of income and unable to support its constituents. To solve the problem, Zimbabwe’s president started printing money.

The historical average exchange rates of Zimbabwe show why so many economists compare this country to post-WWI Germany. At its worst, there was a daily inflation rate of 98%, as citizens clamored to spend their money in the morning before it became useless in the afternoon. At one point, the government considered printing a hundred-trillion-dollar note.

By May 2006, the bulk of the national annual budget of Zimbabwe had already been spent, leaving the government unable to pay its employees and public servants. There were rolling blackouts, uncollected garbage, and diseases such as cholera and dysentery sweeping the country. Forget about buying medication; a roll of toilet paper cost 145,750 ZWD, which converts to 0.69 USD. Unemployment soared to a sweeping 70%, and the government continued to print money. It was reported that most public sector employees made 33 million ZWD per month and still lived below the poverty line.

Today, President Robert Mugabe is still in power, but the Zimbabwe dollar isn’t. The country is dependent on the US Dollar and the South African Rand, and the citizens aren’t eager to adopt another national currency if it means the government will continue printing money as it pleases.

Earlier this summer, the banks had to impose limits on bank withdrawals and selling houses to prevent the same economic collapse as 10 years ago. All trust in the government, economy and currency is gone. Only faith in the dollar and rand remains.

As you can see from these examples, economic instability is often a symptom of a larger cause. For Zimbabwe, it was a corrupt government. For Venezuela, falling oil prices played a large role.

While we truly won’t know the effect of the Brexit on the European and British economies for the next few years, Europe does have the international support to survive whatever the economy throws at it.

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Does any of this sound familiar?

So what can South Africans do about it?

As in Venezuela in recent times, we might see ordinary South Africans flock to Bitcoin. This has already happened in recent years as the volume chart below indicates.

Ordinary people do not have many options when it comes to hedging themselves against a rapid devaluation in the local currency and Bitcoin provides and easy solution.  Bitcoin is relatively easy to buy and has proved itself as a store of value and thus a hedge against a declining currency.

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