Moody’s Ratings Agency has downgraded South
Africa’s sovereign credit rating to sub-investment grade from Baa3 to Ba1 (also
known as junk status).
It has been almost three years since Fitch
Ratings (07 April 2017) and Standard & Poor’s Ratings (03 April 2017)
downgraded South Africa’s sovereign credit rating to below investment grade
following a Cabinet reshuffle by then-president Jacob Zuma, which saw then
Finance Minister Pravin Gordan and Deputy Mcebisi Jonas being fired from their
positions.
The downgrade means that South African
government bonds would ordinarily be removed from the WGBI, resulting in
outflows which on the top end could be as much as $11 billion. However, FTSE
Russel, which administers the WGBI, have put a pause on the portfolio
rebalancing (ie removing SA Govt Bonds) for at least a month. The February WGBI
factsheet reported that SA government bonds had a cumulative weighting of 4.43%
of the WGBI.
Parallels from Brazil
Many of the structural challenges that were
facing the Brazilian economy prior to their sovereign credit downgrade by Moody’s
Ratings Agency are similar to the ones observed in the South African economy.
High debt to GDP levels, an economy in recession, widening budget deficits and
a weaker currency trend against the mainstream currencies – the US dollar, the
British Pound and the Euro.
Moody’s was the last ratings agency to
downgrade Brazil. Brazil’s budget deficit had breached 10% by the time the
downgrade came in February 2016 and debt to GDP rose from 65% to 77% post the
downgrade. However, the currency remained relatively resilient given that most
of the risk had already been priced in their bond yields prior to the
downgrade.
Downgrade already priced in
The local currency has weakened by
approximately 25% since January this year, having traded at R14.01 to the US$
on the 31st December 2019 to trading at R17.57 by close of business
on 27March 2020.
Through a separate lens, the 2018
Ramaphoria saw South Africa’s five-year sovereign credit default spread narrow to
its lowest levels in five years, while this year has seen these widen significantly
since January to the highest five-year level on 23 March 2020.
When credit spreads widen, it’s a sign that
investors are pricing poor credit quality for South Africa. The coronavirus
pandemic contributed materially to the widening of the spreads – accelerating
South Africa’s journey towards a sovereign credit downgrade. This means that
investors have broadly priced in the downgrade and a large portion of it should
be reflected in the current long-term government bond yields.
Yield seeking portfolio flows likely to continue
South Africa is the highest-yielding
currency on in the basket of 14 currencies in the WGBI, making South African
bonds still relatively attractive for high yield seeking investors. And given
that most all the developed economy are expected to have an accommodative
interest rate policy environment further strengthens the case for South African
bonds as a high yield investment destination.
In addition, inflation has tracked below
the mid-point of 4.5% that the SARB models as an inflation target.
This suggests that any inflationary effects
that follow as a result of the credit ratings downgrade are unlikely to result
in price instability or hyperinflation.
Forex Brokers SA reported that the South
African Rand last year ranked 18th (previously 20th) most
traded currency in the world, with an average daily traded volume of US$72
billion – of which 84% was traded by international investors, the highest of
any of the BRICS nations.
An unencumbered economic opportunity
Had Moody’s deferred their decision; the
economy would have continued in the ratings paralysis it had found itself in
recent times, continuously plugging holes just to stave off a ratings
downgrade.
Policy makers now, more than ever, have the
opportunity to grab this bear market by its fur and start planning the
structural reconfiguration of our economy. A strategy to grow long run
aggregate supply needs an economy that best utilises its factors of production
– land, capital, labour and technical innovation.
Sifiso Skenjana is the Chief Economist and Thought Leadership Executive at IQ Business. Views expressed are his own. Follow him on Twitter: @sifiso_skenjana