UPDATE: Here's why the South African rand isn't fazed by Cape Town's water crisis

01/04/18 02:20 PM EST

By Anneken Tappe

Buoyant emerging-market sentiment helps investors shrug off water worries

Cape Town, one of South Africa's biggest cities, is about to run out of water. But the South African rand is taking the crisis in stride thanks to buoyant sentiment in emerging markets, maintaining a rally that got under way in November.

Cape Town has been afflicted by drought for three years, draining its water reservoirs to about a third of capacity. Local groups and news reports also point fingers at the national government led by President Jacob Zuma, which is blamed for misallocating water resources and not releasing drought relief funding in time.

December estimates project that Cape Town will have to turn off its taps on April 29, when its water reserves are expected to fall below 14%, forcing residents to collect water at checkpoints.

Boreholes and seawater desalination could mitigate the crisis, but it seems a race against time. Last year, Cape Town issued South Africa's first municipal green bond, proceeds of which were focused on the water supply.

As of this month, new water restrictions class using more than 10,500 liters (2,774 gallons) a month per household as excessive. For reference, that is roughly in line with the average water consumption per person in the U.S., according to the Environmental Protection Agency.

But investors are focused on other things.

Global growth is set to improve in 2018, manufacturing data is pointing up and commodity prices are rising, which will help emerging market economies. Meanwhile, U.S. yields are subdued and the dollar has been under pressure. U.S. 10-year Treasurys yielded 2.45% on Thursday, compared with a 8.62% on South Africa's 10-year bond South Africa's rand appreciated 9.7% against the U.S. dollar in 2017, and rallied in the first week of 2018.

Sure, South Africa has its risks, but yield always comes at a price, market participants agreed.

"Since the dollar is weak, high beta currencies like the rand are attractive to investors," said Ferhan Salman, Bank of America's South Africa and Turkey economist. The ICE U.S. Dollar Index dropped almost 10% last year.

"South Africa appeals to people because of its high yield and volatility," added Brown Brothers Harriman's global head of currency strategy, Marc Chandler. "The rand had a huge move since November."

"People have been focused on the ANC leadership change, and [Cape Town's water problem] is a very local issue," Salman said.

In mid-December, South Africa's ruling African National Congress party held its leadership election (http://www.marketwatch.com/story/how-this-weekend-could-decide-the-path-of-the-south-african-rand-2017-12-15), determining its presidential candidate for the 2019 election. President Zuma's ex-wife, Nkosazana Dlamini-Zuma, who was expected to continue the current president's poorly received fiscal management, lost the vote to Deputy President Cyril Ramaphosa, who was hailed as the market-friendly, reform-minded candidate. The result sent the rand higher (http://www.marketwatch.com/story/dollar-weaker-as-investors-focus-on-tax-bill-2017-12-18).

On Thursday, local reports said that Zuma could be forced to resign from the national executive committee of his party. The opposition party, the Democratic Alliance, is calling for his impeachment

Ratings agency S&P slashed the nation's investment grade ratings in November due to its fiscal situation. If Moody's followed suit, South Africa would get kicked out global bond indexes and lose a big chunk of its investors. As of now, Moody's is holding off on making a decision, and the February budget release will likely shed more light on the outlook for the country's rating.

Ramaphosa's win may have mitigated this problem, but given that the presidential election isn't until 2019, the deep structural reforms needed, which could also address issues like Cape Town's water crisis, won't be discussed for a while, Salman said.

-Anneken Tappe; 415-439-6400; AskNewswires@dowjones.com

 

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01-04-18 1420ET

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