Roeloff Horne - MitonOptimal South AfricaS&P Global Ratings cut South Africa’s local currency debt score to junk, while Moody’s Investors Service put South Africa on review until February 2018 to be ranked to the same level, raising the risk of a sell-off from global bond indexes and a possible exodus of approximately ZAR 100 billion from S.A. The immediate impact from the S&P local currency downgrade is that SA will be removed from the Barclays Government Bond Index, triggering an estimate of some USD 2 billion of bond sales from SA by month-end from ETFs which track the Barclays Index.

The downgrade by S&P “reflects our opinion of further deterioration of South Africa’s economic growth outlook and its public finances,” the company said in a statement. “Economic decisions in recent years have largely focused on the distribution – rather than the growth of – national income. As a consequence, South Africa’s economy has stagnated, and external competitiveness has eroded.”

If Moody’s also downgrades the local-currency rating, SA rand debt would fall out of indices including Citigroup’s World Government Bond Index, and this could spark outflows of as much as ZAR 100 billion (USD 7 billion). A sell-off of rand bonds — which comprise about 90 percent of South Africa’s outstanding liabilities — would raise borrowing costs for the nation as it sells more debt to plug a widening budget gap.

Although one can be sure there will be true sellers of SA Bonds, it is also the case that they will sell to another investor, who may be seeing value in SA Bonds. Foreign Fund Managers (and locals too) have the ability to buy and sell bonds. The low global yield environment has the effect that investors either get pushed out on the yield curve to accept longer-dated maturities or through acceptance of higher risk in order to generate the yield required (or both!). SA Bonds are already priced at ‘junk status’, but still represent a reasonable balance between risk and reward; it is highly probable, therefore, that the global hunt for yield may continue to benefit a country like SA.

‘The government is considering measures over the next two weeks that will combine tax increases and spending cuts to save ZAR 40 billion in the 2019 fiscal year’, the National Treasury said in an emailed statement. If Treasury statements and President Zuma’s request to the Minister of Finance come true, SA taxpayers can look forward to increased wealth taxes and a VAT increase may also be on the cards, in spite of the fact that it will be an anti-populist move a year ahead of a general election.

Often the fear of a downgrade is overplayed – there are many past examples countries that, having slipped from investment to sub-investment grade, see greater stability in their bond yields and currency after such an event. Indeed, based on markets’ response in the first two trading days that followed S&P’s announcement, this again may be the case in SA, with both the Rand and bond yields having reacted positively to date. That said, when one focuses exclusively on the state of the SA Economy, structural headwinds and continued political uncertainty, it is easy to build a case for a weaker rand.

The December ANC elective conference remains pivotal to indicate the type of leadership we can expect in the future, as the verdict from the Global Rating agencies indicates a clear vote of no confidence in current fiscal and monetary leadership in SA. December 2017 will thus be a watershed moment in SA history, as it may change the path of leadership or may dig SA’s economic grave deeper as the ANC courts job losses and reduced tax income, with less and less ability to pay social grants.

If only the SA Government and ANC leadership can stop corruption, state capture and move its focus away from plans to introduce a nuclear programme, free education and implementing a mining charter…

Some possible solutions may be:

  • addressing leadership, governance, SOE balance sheets,
  • improved fiscal discipline
  • and prioritising inclusive economic growth and job creation

These actions must be implemented soon to avoid a complete exodus of foreign investors, but time will tell.

Weekly Comment – December 7-2017 – RH

 

 

 

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