Will SA slide deeper into junk?

Domestic fund managers are extremely bearish on SA’s prospects of evading full junk status.

That’s according to Merrill Lynch’s October Fund Manager Survey, which found that 80% of fund managers believe Standard & Poors (S&P) and Moody’s will downgrade government bonds to sub-investment grade by the end of 2018, while 13% believe the country will retain its investment-grade rating from these agencies until at least the end of 2017.  

“As a house, we believe that a ratings downgrade of domestic bonds to sub-investment grade is likely to happen in early 2018,” said Merrill Lynch senior director and strategist John Morris, speaking at a Merrill Lynch South Africa media roundtable on the findings of the survey.

Fitch downgraded both the country’s long-term foreign and local currency debt to sub-investment grade following President Jacob Zuma’s March Cabinet reshuffle.

S&P currently rates SA’s local currency debt one notch above junk, while it has a sub-investment-grade rating on foreign-denominated debt. Moody’s still rates both foreign and local currency debt as one notch above junk.  

Should S&P and Moody’s downgrade the country’s local currency debt to sub-investment grade, South African local currency debt will be excluded from Citigroup’s World Government Bond Index, a step that will trigger significant outflows.

Standard Chartered estimated the size of potential outflows in the case of a downgrade to “full junk” at $10bn, with Bank of America Corp putting the number at $14bn, Bloomberg reported at the end of October.

The likelihood of SA’s downgrade to full junk appears largely linked to the outcome of an impending event on the country’s political calendar – the ANC’s elective conference in December. Most fund managers are rand-hedged going into the conference, expecting a binary outcome that could either – positively – result in policy reform, or – negatively – see little political change.

Around 60% see “policy shifts to the left” following the elective conference as the biggest risk to SA equities.   

“As we go into the elective, fund managers are unsure of how to position for it. A reform outcome is seen as being positive for the rand and a non-reform outcome negative for the rand. This is the dilemma for managers,” said Morris.  

But even political reform could not be enough to halt a rating slide. SA’s debt rating could still be pushed downwards by uncertainty surrounding the 2019 national elections, the shambolic state of state-owned enterprises and the country’s worrying debt path.  

“You need a reform outcome to avoid losing investment grade and to get state-owned entities back on track – a [Cyril] Ramaphosa outcome.

However, we could even have a favourable reform scenario but if the world economy rolls over next year, it’s bad for the rand and our debt rating,” he commented.  

Finance minister Malusi Gigaba’s recent Medium-Term Budget Policy Statement, which was seen as providing little in the way of fiscal direction, could further prompt a sovereign rating downgrade by agencies, particularly as SA’s interest payments ratio exceeds the median of its peer ratings group.

This indicator was earlier pegged by Moody’s as a worrying sign of continuing fiscal imbalances and a high debt burden.

SA’s fiscal challenges notwithstanding, panellists at a recent chartered financial analyst (CFA) annual investment conference in Johannesburg suggested, however, that a sovereign rating downgrade to junk status would not necessarily sound SA’s economic death knell.

Noting that it was “easy to obsess over credit ratings”, Aluwani Capital Partners macro strategist Mamokete Lijane said SA’s potential slide to junk status should be put into perspective. SA has not always enjoyed an investment-grade international debt rating and would likely adjust to a junk status reality.  

“As the investment community, we need to stop thinking that investment grade is the only investment grade. We need to accept that a sub-investment grade may be around for a while. We’ll have a period of uncertainty and then things will settle down after a confidence shock.   

“We’ll need to get used to more expensive debt… [but] a downgrade doesn’t necessarily mean you won’t get money in. It just means that the money coming in will be more volatile,” she told the CFA conference.  

S&P Corporate Ratings director Omega Collocott was somewhat more pragmatic, saying that a rating downgrade would increase the cost of borrowing for government and maximise the debt-risk
rating issued to SA corporates.  

“There are no hard limits on the rating for corporates, but a sovereign downgrade makes access to capital for the whole of corporate SA a lot more difficult,” she cautioned.
Collocott said ratings are designed as a single indicator of market performance and should be used in conjunction with a suite of analyses in any investment decision.  

“They are one set of market signals, they are not the be all and end all. They won’t tell you if a bond will trade lower tomorrow; it’s a benchmark,” she remarked.
Agencies are expected to review SA’s sovereign debt rating on 24 November. 

This article originally appeared in the 16 November edition of finweek. Buy and download the magazine here.

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