The global economy continues to face headwinds due to the outbreak of the COVID-19 virus and the subsequent lockdown of many economies. The impact will reach every business as pipelines and customer bases are affected but there are measures to manage the threat.

This article first appeared in ESI Africa Issue 3-2020.
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The South African economy has been severely disrupted and seen large contractions in its GDP due to the lockdown. Even essential services have been impacted through supply chain inefficiencies, production capacity not at optimal levels, and demand for goods being reduced through knock-on effects of some of their customers being on forced lockdown.

Given these shocks, many countries are looking at resetting national budgets, creating more business-friendly environments to stimulate activity post lockdown, and investing in infrastructure projects. Fortunately, in South Africa, the energy sector is one of those that is seeing change, albeit slow, in terms of structural reforms, allowing for private sector investment and some progress on clearer rules on self-generation.

South Africa has one of the most volatile exchange rates in the world, which adds a level of complexity in determining the value of future input costs.

Disruptions to supply chains have been another key feature of the global pandemic. This was evident in the solar industry with panel and inverter supplies as well as prices being impacted due to the shocks in China and to the global supply chain.

Things to consider when hedging your bets…

In addition to all these factors, the volatility of the South African Rand is another critical component affecting the industry. One negative feature of the country’s lockdown (in terms of the importing of technologies and importing raw materials for locally manufactured goods like batteries) is a weaker Rand.

South Africa has one of the most volatile exchange rates in the world, which adds a level of complexity in determining the value of future input costs (when denominated in a foreign currency). Understanding the exposure to foreign exchange rates and how to manage this is important, especially in an environment where every cent counts towards an already strained bottom line or the need to price projects competitively.

The Rand has weakened substantially against the US dollar (USD) this year, hitting a peak of R19.35 per USD at the start of April, before rallying to R16.52 per USD and depreciating back to R17.26 per USD on 24 June. This drop has come on the back of heightened global risk aversion associated with the COVID-19 pandemic and the possibility of a protracted downturn in the US economy due to the pandemic.

Understanding your sensitivities to exchange rates and the hedging thereof can give you more control.

If the South African economy is able to restart as lockdown measures ease, there are a few scenarios that could lead to the strengthening of the Rand:

1. Capital inflows: Where local asset managers are above their offshore investment allowances as a result of the weakening of the Rand and a sharper sell-off of domestic markets compared to international markets, there is a need to repatriate some of their offshore investments.

2. Valuations: From a purchasing power parity perspective, the trade-weighted Rand looks undervalued. With inflation surprising to the downside in June and likely to continue to moderate, there could be cause for the Rand to strengthen. In other words, for a basket of goods in Rand terms to equal the cost of the same basket of goods in other currencies the Rand needs to appreciate.

3. Carry trade: If the South African Reserve Bank does not continue to cut rates, and global volatility levels continue to reduce this could enhance the Rand’s carry trade appeal. In other words, in the search for returns South African bond yields may be more attractive to foreign investors and lead to an inflow of funds into South Africa.

There are also risk scenarios, such as global risk aversion, that could see the Rand depreciate. There have been substantial outflows from the South African bond and equity markets, with bond outflows due in part to SA’s sovereign credit rating downgrades from both Moody’s and Fitch and SA’s exclusion from the World Government Bond Index. The deteriorating fiscal position and budget deficits do not support Rand strength. Global investors may feel a fresh wave of risk aversion due to COVID-19 related fears which will see a weaker Rand.

Options for role players in the energy sector

Hedging Rand exposure might give role players in the energy sector more control in this highly uncertain environment. Due to the open nature of the South African economy and its mature financial markets, the Rand is a highly volatile currency and a variable that is outside of the control of energy sector companies who are exposed to the exchange rate.

As per the examples above, predicting the Rand is a combination of multiple factors and difficult to forecast. In this unpredictable environment planning around cash flows is key and paying a premium to hedge this variable and better understanding of your inflows and outflows as they relate to foreign exchange exposures may be a prudent practice. This also allows you to hedge the pricing on projects. Successful management of foreign currency revenues or input costs can optimise your effort to limit margin pressure.

About the author

Justin Schmidt

Justin Schmidt heads up New Sector Development at Absa Retail and Business Bank where renewable energy, tourism and manufacturing are focus sectors in this portfolio. He is responsible for the strategy, customer value proposition and growth targets in these sectors, which are also key sectors for the South African economy.