What a ratings downgrade means for the rand

There is a very good chance that at least one of the major ratings agencies will downgrade South Africa to sub-investment grade during the course of 2016.

This is according to Adrian Saville, chief strategist at financial advisory group, Citadel Investment Services, who noted, however, that a downgrade has already been priced into the market.

Reuters noted that the rand has regained most of the losses incurred in December after President Jacob Zuma sacked the finance minister, but remains vulnerable to global turmoil and the domestic threat of a credit rating downgrade.

Deputy central bank Governor Daniel Mminele said on the weekend that the steady depreciation of the rand over the last five years was of particular significance for monetary policy.

The rand gave up 1% against the dollar in morning trade in line with other commodity currencies hit by a slide in oil prices. It traded at R14.70 against the dollar at 10h00 on Monday.

Saville said there are a number of technicalities involved in any decision that will result in South Africa being rated “sub-investment grade” or, perhaps less emotively, “high yield”.

“On a positive note, these technicalities could prevent South Africa from being pushed out of the World Government Bond Index (WGBI),” he said.

Such an ejection would represent possibly the most dramatic outcome of a ratings downgrade and should be South Africa’s biggest cause for concern.

For the country to be ejected from the WGBI it would require our rating on rand-denominated debt to be classified sub-investment grade and both Moody’s and Standard & Poor’s (S&P) would need to make this assessment, Citadel’s strategist said.

Saville said that media attention has focussed on the ratings agencies’ views on foreign currency-denominated debt, which is one step away from “sub-investment grade” in the case of S&P, and two steps away in the case of Moody’s.

“However, we are currently at least two steps away from this when it comes to rand-denominated debt. Thus, for both the agencies to deem South African government bonds sub-investment grade requires more than one step by a single agency,” he said.

Using the macroeconomic variables that matter – such as economic growth, the current account deficit, government debt and the budget deficit – it is hard to escape the conclusion that South Africa ranks at the “bottom of the B class”.

“By these criteria we deserve to be downgraded. However, it is not all bad news for South Africa. One of the redeeming features of our economy includes institutional strength, highlighted quite forcibly in recent weeks by the rulings of the Constitutional Court,” Saville said.

What about the rand?

The big question to ask is what a downgrade would mean for the rand, the JSE, inflation, interest rates and the economy as a whole, said Savill.

On this score, he said that there is an argument to be made that South African markets were priced for the worst at the start of this year, particularly the bond and currency markets. More recently, South Africa’s benchmark bond was priced at 9.25% and the rand was trading in the region of R15 to the US dollar – both prices much stronger than the start of the year but still well below fair value and purchasing power parity, respectively.

“From this, our view follows that if a downgrade occurs it is already in the price. By contrast, anything that points to South Africa staving off a downgrade or showing signs of stability and, ideally, structural strength, will help the rand, the bond market, other capital markets and, arguably, economic growth.

“To some extent, aspects of this already seems to be happening, with the rand and bond prices improving on the back of the appointment of Pravin Gordhan as Finance Minister, the reading of the government budget in February and the recent Constitutional Court ruling, among other things,” Saville said.

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What a ratings downgrade means for the rand