* Rate cut would slow capital inflows
* Markets pricing in cut at March 28 meeting
* Rand, debt has rallied since Ramaphosa took charge
By Mfuneko Toyana
JOHANNESBURG, March 9 (Reuters) - After the first VAT hike since apartheid, South African consumers are calling for an interest rate cut but the central bank has numerous reasons to resist this pressure, chief amongst them a desire to sustain an inflation-busting rally in the rand.
Since market-friendly Cyril Ramaphosa took over from Jacob Zuma as president last month, South African bond yields have fallen and the currency has soared on expectations he will reinvigorate the economy after years of stagnation and mismanagement.
Despite the rally, domestic yields remain more than 4 percent higher than those on comparable U.S. debt, making South Africa’s “carry trade”, as the differential is known, one of the most attractive emerging market debt plays after Russia.
But the need to raise VAT for the first time in more than two decades to plug a hole in the national finances may bring that rally to a halt.
South Africa’s powerful trade union movement and consumer groups have been vocal critics of rise in VAT from 14 to 15 percent, and are demanding a rate cut to ease the pain.
Forward rate agreements this week were pricing in a nearly 80 percent chance of a 25 basis points rate cut to 6.5 percent in the benchmark lending rate.
That would bring South Africa’s carry trade differential closer to Indonesia’s 3.2 percent.
Forecasting a cut, Bank of America Merrill Lynch is recommending investors sell South African debt and the rand, which it thinks is overvalued.
“Due to the recent rally we think risk/reward is to the downside,” BAML senior economist Ferhan Salman said, recommending a shift into Turkish bonds, which he believes are on an upswing.
BAML, which has a history of going against prevailing market sentiment on South Africa, sees the rand at 13.50 to the dollar by year-end from 11.92 on Friday.
Conversely, if the Reserve Bank holds fire at its March 28 policy meeting, as it has on the last three occasions, analysts predict another surge in the currency.
Headline inflation slowed to 4.4 percent in January, the lowest in three years and in the middle of the Reserve Bank’s 3-6 percent target range, but the bank sees price growth at 5 percent in the final quarter.
The VAT increase is also likely to push that forecast up.
Another factor weighing against a cut is the likelihood of higher rates in the United States this year, a rate trajectory that also eats into South Africa’s relative attractiveness to sovereign debt funds. “Should the SARB reduce interest rates, the rand’s carry-trade appeal would wane against on relative EM basis,” said Nedbank technical strategist Mehul Daya.
“SARB policies do not target the rand. However, policy makers are aware of the importance and influence of the carry-trade,” Daya said.
Reporting by Mfuneko Toyana, Graphic by Ritvik Carvalho; Editing by Toby Chopra