South Africa's Currency Repricing: Why Investors Are Undervaluing the Rand

Johann Els, Chief Economist at PSG Financial Services, is making a case that cuts against fifteen years of received wisdom in currency markets: the rand’s long-term equilibrium is shifting upward, and investors who keep applying the old depreciation framework are mispricing South Africa’s improving fundamentals.

The conventional view, historically grounded and widely held, treats rand weakness as a structural constant. Els argues that this framing no longer captures the full picture, and that the distinction carries real consequences for asset allocation and portfolio positioning. Markets reward improving fundamentals, not static ones.

The 2002-to-2008 cycle illustrates the mechanism. During that period, South Africa delivered stronger economic growth, improved fiscal discipline, declining government debt, repeated sovereign ratings upgrades and rising investor confidence. The currency strengthened materially in response. The global environment and commodity markets have shifted since then, but the historical lesson holds: exchange rates respond to improving conditions. They do not move in a single direction indefinitely.

Several ingredients of that earlier period are beginning to reappear. The growth outlook is gradually improving as structural reforms gain momentum. Private sector participation in electricity has fundamentally altered the energy landscape. Logistics reforms are under way. Operation Vulindlela continues to remove important bottlenecks. The fiscal position has strengthened meaningfully, with government running sustained primary budget surpluses and debt appearing close to peaking as a share of GDP. Ratings agencies have become increasingly constructive, and a gradual return to investment-grade status is a realistic medium-term prospect.

Structural strengths that tend to get overlooked during periods of pessimism provide additional ballast. The Constitution remains strong, the judiciary independent, and institutions such as the Reserve Bank and National Treasury continue to carry considerable credibility. South Africa also operates one of the most sophisticated financial sectors in the emerging world, backed by a resilient private sector. That institutional base is stronger than the prevailing narrative typically acknowledges.

Meanwhile, the global backdrop has shifted in ways that could support the rand. Els believes the US dollar has entered a multi-year weaker cycle after more than a decade of strength. Large fiscal and current account deficits, an exceptionally high debt burden and the enormous foreign capital that has flowed into US financial markets over the past decade are unlikely to provide the same support for the dollar going forward. A structurally weaker dollar has historically been supportive for commodity prices, emerging markets and commodity-producing countries. That should improve South Africa’s terms of trade and external accounts, reducing one of the traditional sources of rand vulnerability.

The relative positioning of developed and emerging economies has also changed. Twenty years ago, developed economies generally offered stronger growth, lower debt and lower risk. Today many of them struggle with weak productivity growth, ageing populations and debt levels that would once have been associated with emerging markets. Many emerging markets, by contrast, have strengthened their policy frameworks and public finances. Investors compare opportunities across countries rather than assessing them in isolation. South Africa does not need to become perfect; it simply needs to improve relative to the alternatives.

The inflation regime deserves particular attention from investors. If inflation averages closer to 3% over time, South Africa’s inflation differential relative to its major trading partners should narrow. The rand should still depreciate gradually over the long run, but the pace of depreciation could be materially slower than what has occurred over the past decade. Lower and more stable inflation should gradually reduce the country’s risk premium, lower long-term borrowing costs for both government and the private sector, ease the government’s interest burden and support a more stable currency. Stronger growth, lower borrowing costs and improving public finances reinforce one another in ways that compound over time.

Volatility will remain a defining characteristic of the rand. South Africa has one of the deepest and most liquid financial markets in the emerging world, with no exchange controls on foreign portfolio investment. Global investors frequently use the rand as a proxy for emerging market risk precisely because it is easy to trade. During periods of global uncertainty, the rand will continue to overshoot, often regardless of domestic conditions. But volatility should not be confused with long-term direction. Currencies fluctuate around their long-term equilibrium, and that equilibrium is gradually improving.

The nature of capital flows into South Africa could also change. For many years investors were attracted mainly by the carry trade or commodity exposure. As confidence improves, reforms gather momentum and South Africa moves closer to investment-grade status, a greater share of capital could be driven by long-term investment in businesses and productive assets (the kind of flows that tend to be stickier and more durable than carry-driven positioning). That would provide additional structural support for the rand over time.

If South Africa continues to implement structural reforms, maintains fiscal discipline, gradually returns to investment grade, anchors inflation closer to 3% and benefits from a more supportive global environment, the next decade could look rather different from the last. The rand will remain an emerging market currency, volatile and subject to periodic weakness. But the more significant shift may not be in the currency itself. It may be in whether global capital finally starts pricing South Africa as a country on an improving trajectory rather than a deteriorating one.