Moody’s Investor Service will deliver a review on South Africa on Friday, with most analysts expecting the country to avoid a downgrade to full junk status, with a more likely outcome being a change in the outlook from stable to negative.
Moody’s is the only credit rating agency yet to downgrade the country to junk status. It has retained South African debt ratings at investment grade since 2017, with this now on review.
Ian Matthews, head of Business Development at Bravura, an investment banking firm specialising in corporate finance and structured solutions services said: “At the time, the agency said the review period would allow it to assess the South African authorities’ willingness and ability to respond to the rising pressures through growth-supportive fiscal adjustments that raise revenues and contain expenditures; structural economic reforms that ease domestic bottlenecks to growth; and improvements to SOE governance that contain contingent liabilities.”
Following president Cyril Ramaphosa’s first state of the nation address last year, Moody’s upgraded the credit outlook from ‘negative’ to ‘stable’ and this action seemed to indicate hopes of economic growth and fiscal prudence, Matthews noted. However, Budget 2019 has not been able to demonstrate any meaningful remediation, he said.
Currently South Africa is rated by Moody’s at Baa3, which is one notch above sub-investment grade. Ba1, -2 and -3 are below investment grade and deemed junk status. South African has been rated below investment grade since 2017 by ratings agencies Standard & Poor and Fitch.
Should Moody’s also downgrade South Africa to junk status, the country would no longer be eligible for inclusion in debt gauges such as Citigroup Inc’s World Government Bond Index (WGBI).
“Having satisfied the three criteria of size, credit quality and lack of barriers to entry in 2012, the inclusion of the South African Government Bond Index marked the first African government bond market to be included in the WGBI,” said Matthews.
“A downgrade by Moody’s would render South Africa unable to meet the required credit quality and could potentially see forced outflows of capital amounting to as much as $10 billion.”
Eskom, the “biggest threat to South Africa’s economy” and the most compelling reason to downgrade may keep the country out of junk. “Moody’s might not flip the switch on Friday, opting to wait out government’s proposed plans for turning the utility around.
“This would potentially give South Africa another few months or years in which to implement remedial strategies. If this is to be the case, make no mistake that it would be our final warning,” Matthews said.
According to Bianca Botes, corporate treasury manager at Peregrine Treasury Solutions, the local currency faces four potential outcomes following Moody’s decision on Friday.
These outcomes include:
- No downgrade: Moody’s keeps the South African outlook at stable, with no downgrade in the sovereign rating. This announcement would be rand positive in the immediate and short term, however any retracement would be limited by the dominant global environment;
- Outlook changed from stable to negative (most widely expected outcome): Moody’s keeps the sovereign rating unchanged, while the outlook is changed from stable to negative, likely giving SA a stern warning about fiscal expenditure and growth concerns. The impact on the currency would likely also be positive in the immediate and short term, however, the change in outlook opens the door for a potential downgrade in November;
- Downgrade (largely unexpected): Moody’s cuts the sovereign rating, as well as changes the outlook from stable to negative. The rand would most likely have a knee-jerk reaction in the short term, potentially breaking the R15.00/$ mark;
- Postponement: Moody’s takes the decision to wait until after the election to make its decision. This would leave the market in limbo, but a small retracement in the currency could be expected.
Botes noted that the local currency has come under pressure again this week as Turkey prepares for elections this weekend that will challenge the control of president Erdogan.
The rand and Brazil’s real witnessed a spike in their expected volatility, signalling concern they may weaken the most along with the lira over the next month. The price-swings have evoked memories of last year when a meltdown in the Turkish exchange rate spurred panic selling across emerging markets, Bloomberg reported.
The spillover in the South African market has been brutal, with the rand retreating against all major currencies, and topping R14.73/$ on Thursday afternoon after trading in the mid R14.20s at the start of the week, said Botes.
“While Turkey’s woes are largely overshadowing the rest of the global market, local pressures continue to contribute to the rand’s turmoil. Even though the lights are on for the time being, load-shedding will form part of the South African environment for the foreseeable future, which will have a devastating ripple effect across all sectors of the economy,” she said.
Thursday afternoon saw the SARB Monetary Policy Committee announce that the repo rate would remain at 6.75% and that future inflationary pressures would be largely attributable to higher Eskom tariffs, rising fuel costs, as well as a weaker rand.
SARB governor Lesetja Kganyago, also warned of the effects of a sluggish global growth environment, as well as the current global market dynamic, listing trade tensions and Brexit as some of the key risk factors, said Botes.
“The governor delivered more negative news: that local growth is more subdued than initially anticipated and the growth forecasts have been revised down from 1.7% to 1.3% for 2019,” she said.
At 08h00 on Friday the rand was trading at the following levels against the major currencies:
- Dollar/Rand: R14.60 (-0.05%)
- Pound/Rand: R19.08 (0.16%)
- Euro/Rand: R16.40 (0.02%)