Analysts that have been following South Africa do expect that it will lose its final investment grade rating, however, they disagree on what might happen and the consequences of such.
The worst prediction is that it would trigger outflows of over $10 billion and will cause the rand to weaken to its lowest level in almost four years. On the other hand, some say that investors have already priced in a downgrade and South African assets could even rise in the aftermath, especially if the feeling towards emerging markets stays strong.
On November 1st, Moody’s Investors Services cut its outlook to negative. They rate South Africa at Baa3, which is just a step above speculative grade. This followed the budget statement from Finance Minister, Tito Mboweni, which showed that the financial situation of the government is rapidly deteriorating.
If South Africa is downgraded by Moody’s then rand bonds will be omitted from FTSE World Government Bond Index, which includes 14 currencies such as the dollar and yen and has about $3 trillion tracking it according to Bank of New York Mellon. According to National Treasury data, foreign investors own 37% or about R780 billion of South Africa’s local currency bonds.
So, what are the analysts saying?
Bank of America
The US lender expects that downgrade could happen soon after February’s budget review. They don’t believe that the government will be able to fix the growing fiscal gap or debt laden Eskom. However, Jure Jeric and David Hauner said that markets have priced this in and outflows, might only reach $1.5 billion, especially if tensions over trade ease between the US and China as they continue to float emerging markets. In a note this month they said that South African assets are cheap and post downgrade, the market is likely to rise as uncertainty declines.
Bank of New York Mellon
Head of markets strategy, Daniel Tenengauzer predicts that if South Africa exits the WGBI then the outflows could be between $8 billion and $12 billion. The selling might not be curbed by the status as the highest yielding country in the index. On average, rand bond rates are 9.2%, about 360 basis points more than those for the second highest yielding currency, which is the Mexican peso.
According to Gina Schoeman, an economist at the Wall Street Bank, a downgrade in March is possible if South Africa can’t come up with a credible debt stabilisation strategy. There will then be tough negotiations ahead between the government and unions on how spending can be curbed. She went on to say that a WGBI exit could mean between $6 billion and $7 billion of capital could leave the country as it appears that Moody’s tolerance is low.
Peter Attard Montalto, London based head of capital markets research said that it’s 50/50 on whether South Africa will avoid a downgrade after the February budget. He said that to a moderate degree a cut has been priced in and could result in $5 billion of outflows.
The banks Johannesburg based chief economist, Annabel Bishop said that a negative outlook instead of a ratings watch could mean that South Africa will be granted up to 18 months by Moody’s to improve its finances. If there is a downgrade, then the governments 10-year local currency yields may increase to about 10%, but they probably won’t rise as much as those in Turkey and Brazil when they were cut to junk.
Rand Merchant Bank
Fixed income analyst at the Johannesburg based investment bank, Kim Silberman said that Moody’s marked South Africa down due to its politics. She went on to say that a downgrade in March is now possible and the rand may drop to 16 per dollar, which is 7.6% weaker then it is currently and the lowest it has been since early 2016. Schwellnus, a bond trader at RMB said that outflows could be between R30 billion and R200 billion, but he went on to say that this global environment is probably the most ideal for a downgrade to happen in.
Razia Khan, the bank’s London based chief economist for Africa and the Middle East said that they do not see a downgrade as early as March as being at all likely. Rather the negative outlook from Moody’s gives the authorities the political cover they might need to take a firm stance on reforms and a pickup in growth next year may mean a cut’s avoided altogether. Samir Gadio, StanChart’s head of Africa strategy said that even if it isn’t, estimates of outflows of around $10 billion look very overstated.
Article Source: https://www.moneyweb.co.za/news/south-africa/this-is-what-awaits-south-africa-if-moodys-cuts-its-rating-to-junk/