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South Africa’s Zuma embarks on a game of chicken with markets

If President Jacob Zuma of South Africa wanted to know how markets would react if he sacked Pravin Gordhan as finance minister, he got part of the answer this week.

The rand shed 4.4 per cent of its dollar value earlier this week after Mr Zuma ordered Mr Gordhan to cancel a roadshow with investors on the first day and fly home from London, without explanation. The rand has been spinning in the wind since, as Mr Zuma stays silent and speculation see-saws over Mr Gordhan’s future. Yet this may be only a taste of what is to come.

The president and his finance minister have been locked for months in an increasingly terminal-looking conflict, as Mr Gordhan’s striving for fiscal discipline clashes with Mr Zuma’s taste for public spending and patronage, often referred to as “tenderpreneurship”. Some reports say the relationship has broken down beyond repair.

Investors might have seen it coming. But many were not paying attention, says Peter Attard Montalto of Nomura, choosing to focus instead on a broad emerging market rally that has been especially beneficial to commodity exporters such as South Africa.

“The market got bored with the endless speculation and starting playing the terms of trade rally and priced out political risk to zero,” he says. “But markets have missed the wider context. They see Zuma’s patience as a sign of weakness, whereas he has been biding his time.”

1. President Jacob Zuma replaces finance minister with unknown backbencher
2. Pravin Gordhan appointed new finance minister
3. Media leaks reveal Mr Gordhan received a letter from the Hawks, a special police force, questioning him about a South African Revenue Service unit
4. The Hawks accuse Mr Gordhan of failing to meet deadlines to answer its questions
5. South Africa’s presidency denies Mr Gordhan faces arrest over the investigation
6. Mr Gordhan says he will not comply with a request to appear before an investigative unit of the police
7. Mr Gordhan summoned to face fraud charges
8. Presidency orders Mr Gordhan back to South Africa from roadshow

In Mr Attard Montalto’s view, Mr Zuma has been playing the long game for two years, waiting for the moment to pack his cabinet with supporters and secure the ability to chose his successor when he steps down as leader of the ruling African National Congress in December and as president of the republic in 2019.

The botched dismissal of a previous, well-regarded finance minister in December 2015, an episode that ended with Mr Gordhan’s appointment, was a step along the way. Since then, the reasoning goes, Mr Zuma has been preparing the ground. Meanwhile, the rand has appreciated powerfully, giving an ample cushion for any untoward market reaction.

Indeed, Mr Attard Montalto thinks Mr Zuma and his supporters will judge the market reaction this week as muted, adding to the chances that — in the face of stiff resistance in the ANC leadership — Mr Gordhan may be fired in the coming days.

If so, Mr Zuma may be in for a shock. Kevin Daly of Aberdeen Asset Management says the rand, which fell from an intraday peak of 12.3 to the dollar on Monday to about 13 on Thursday, will crash back through 14 and even test 15 if Mr Gordhan goes and if, as expected, rating agencies react by stripping South Africa of its valued investment grade status.

“You could say there’s been some complacency that Zuma wouldn’t go for the nuclear option before the end of the year,” he says, “but at the same time, he has got to realise that doing so will cause fractures in the ANC and shows pretty poor judgment.”

It is not only the currency that would suffer. South Africa is unusual in that a large proportion of its domestic government bonds are held by foreign investors — about 44 per cent in January, according to estimates by Morgan Stanley. If they sell when trouble strikes, the government’s borrowing costs will rise significantly, stacking more fiscal trouble on top of a budget deficit estimated at 3.4 per cent of gross domestic product.

Here, too, this week gave a taste of what may come. The yield on the benchmark 10-year local bond started the week at 8.28 per cent and hit a high of 8.91 per cent on Monday before easing to about 8.7 per cent.

Yet even after this week’s turmoil, South Africa has been a good bet for investors: the rand has slipped from first to third place in the list of the world’s best-performing currencies of the past year.

Some foreign investors will stick with it for lack of alternatives. Many dedicated regional investors want to be underweight Turkey, and it is hard for them to be underweight both Turkey and South Africa, Mr Attard Montalto notes.

Others hope for a better future after Mr Zuma. The succession is likely to be a battle between Cyril Ramaphosa, the deputy president seen as the orthodox option, and Nkosazana Dlamini-Zuma, Mr Zuma’s favourite and former wife.

But Mr Attard Montalto thinks both would end up disappointing investors. “For me, with either of the two, you end up with subinvestment grade,” he says. “Under Dlamini-Zuma we would get there faster. Under Ramaphosa there’d be a rally that wouldn’t last or result in real reform.”

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