Here’s what the markets made of South Africa’s budget

South Africa’s rand snapped three days of gains and fell the most among emerging-market peers after Finance Minister Tito Mboweni blindsided markets with a speech in Cape Town that outlined higher fiscal deficits and warned that state revenue will continue to undershoot.

Here’s the reaction from traders, analysts and economists:

Piotr Matys, an analyst with Rabobank: Mboweni’s budget was “the opposite of what the market was hoping” for “It’s also a timely reminder that the country faces tremendous fiscal challenges amid weak economic activity constrained by structural issues.”

Win Thin, strategist at Brown Brothers Harriman: “I was clearly too optimistic that Mboweni would announce enough fiscal tightening to keep the ratings agencies at bay.

“Risks of downgrades have gone up significantly.”

Bernd Berg, strategist at Woodman Asset Management: “South Africa remains stuck in a low growth, high-debt environment and it is difficult to get euphoric about the outlook for the rand at this juncture.

“With little positive domestic drivers and a challenging external environment, especially for South Africa’s main export partner China, it is hard to see the ZAR outperform its EM peers in the short run.”

Razia Khan, chief Africa economist at Standard Chartered: “The initial, knee-jerk reaction of the market to the budget was understandably negative” and markets started to price in less benign ratings reviews.

“Still, “we believe that the tax buoyancy assumptions in the medium-term are deliberately conservative.”

“Even the revenue ‘miss’ in the current year is arguably due more to VAT rebates – a good thing, which ultimately strengthens tax compliance – rather than just the growth slowdown.

“Although the higher debt path outlined may trigger some concern, this is no justification for a downgrade in itself from Moody’s.”

Hans Gustafson, a strategist at Swedbank: It will be a “very challenging” environment for South Africa “with a higher borrowing requirement in an environment with tight US liquidity and global weaker growth”.

“The rand needs to incorporate a higher risk premium.”

Mehul Daya, an analyst at Nedbank: It’s a “double whammy” for the rand and local-currency bonds as the budget was disappointing and a weaker euro is strengthening the dollar This means South African assets face internal as well as external headwinds.

Kevin Daly, a money manager with Aberdeen Standard Investments: South Africa’s budget was “somewhat of a disappointment” given that the deficit target for 2018-19 was increased to 4% from around 3.5%.”“But we don’t think this is enough to prompt action by Moody’s to change the outlook to negative.”

The rand meanwhile weakened the most among emerging-market peers and bond yields climbed to the highest this year as the government’s latest debt projections increased the probability of a credit-rating downgrade that would move South Africa’s local-currency debt into junk status.

Mboweni said government debt will peak two years later, and higher, than previously forecast, the fiscal gap will widen further and state revenue will continue to undershoot.

The news is likely to weigh on rating companies including Moody’s Investors Service, which delayed reviewing the country’s debt rating earlier this month. Moody’s is the only one of the three major rating firms to assess South Africa’s debt at investment level.

A move lower would spark forced selling of bonds by investors who track investment-grade debt indexes including Citigroup Inc’s World Government Bond Index.

Foreign investors own 38% of South Africa’s R1.97 trillion ($136 billion) of local-currency bonds, making the country vulnerable to capital flight. Outflows could reach $5 billion should the country lose its membership of the WGBI, according to Bank of America Merill Lynch.

“I don’t think this budget does SA Inc any favors,” said Halen Bothma, an economist at ETM Analytics in Johannesburg. “It doesn’t instill confidence in the market about the South African government’s ability to tackle its fiscal imbalances. We are leaning towards a higher probability of a downgrade.”

The rand declined as much as 2.2%, reversing a gain of 0.8% before the budget speech. It traded 2.1% down at R14.57 per dollar by 7:34 p.m. in Johannesburg. Benchmark 2026 government bonds fell, driving the yield up 15 basis points to 9.31%, the highest since December.

“South Africa remains stuck in a low-growth, high-debt environment and it is difficult to get euphoric about the outlook for the rand,” said Bernd Berg, a foreign-exchange strategist at Woodman Asset Management AG in Zug, Switzerland.

“With little positive domestic drivers and a challenging external environment, it is hard to see the rand outperform its emerging-market peers in the short run.”

South Africa’s benchmark stock index closed 0.6% lower after gaining as much as 0.6% earlier.

Read: The 2018 mid-term budget speech in a nutshell

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Here’s what the markets made of South Africa’s budget