Despite the hype around the latest sovereign downgrades, South Africa has not hit rock bottom, nor has it experienced the worst-case scenario – a full downgrade to junk to include local currency debt ratings.
Hanging in the balance, in particular, were the potential further downgrades of the nation’s local debt by ratings agencies S&P Global Ratings and Moody’s, both of which still currently maintain the local currency ratings at investment grade, Econometrix director and chief economist Dr Azar Jammine said at a recent event hosted by Cliffe Dekker Hofmeyr.
“It is a misnomer to say [South Africa has] gone junk – we actually have junk on only a portion of debt – the rest of it is still investment grade,” he said, noting the differing ratings approaches of the three ratings agencies and the differentiation of rand and foreign currency-issued debt.
S&P downgraded South Africa’s foreign currency debt in April, while Fitch downgraded both the foreign and local currency debt to junk status shortly thereafter.
Moody’s, which previously maintained South Africa’s investment grade two notches above junk status, has put South Africa on review for a downgrade. A decision is expected in July.
“We haven’t had the worst-case scenario of a collapse in the rand that will cause our interest rates to soar,” he told participants in a ‘junk status’ seminar, in Sandton, pointing out that many positives still remained and many of the expected negative outcomes of becoming a subinvestment grade country had been somewhat muted.
The real threat lay in the possibility of further downgrades to local currency ratings, as opposed to foreign currency ratings, and of South Africa, consequently, being booted from bond indices, particularly the Citigroup World Government Bond Index (WGBI), of which South Africa’s bonds accounted for 12%, Jammine explained.
South Africa was included the WGBI in 2012, representing 0.45% of the index’s market value.
Dropping out of that index would cause a $10-billion outflow, which would cause the rand to tumble, he said.
“But, right now, we are not there yet,” Jammine said, adding that some 90% of the South African government bonds held by foreign investors were in local currency debt and that was why the impact of the initial downgrade did not result in a mass outflow in funds.
“Therein is the crucial caveat in terms of our outlook: will S&P and Moody’s downgrade us to junk status?” he queried.
S&P is scheduled to review South Africa in June, as it was initially expected before the Cabinet reshuffle sparked an early April review, while Moody’s is currently reviewing the country and will publish its decision by July.
“It is possible they may go ahead and downgrade us, but it will not be before at least the end of the year [and into 2018] before we see any form of downgrade,” he said.
“It is not a new thing for South Africa to be in junk and, technically, only a portion of it was in junk,” he reiterated, commenting that the disappointment emerged from the timing of the downgrades – a moment where positivity was starting to shine through and South Africa was on a path of recovery.
He cited the overestimated negative impact of the drought, the dissipation of electricity constraints, stable industrial relations, lower- than-expected inflation, the unlikelihood of interest rate hikes and strong business balance sheets.
However, the rand did not take “as much of a beating” as was expected since the downgrades six weeks ago, part of it owing to the fact that the currency is still quite cheap, and this presented exporters with a significant opportunity.
With commodity prices recovering and the rand relatively “cheap”, South Africa’s exports were able to surpass imports for the first time in six years.
“We now export more than we import. The cheapness of the rand is giving us some opportunity,” he explained.
In addition, while South Africa’s growth had stalled, its African neighbours were expected to deliver low double-digit and high single-digit growth rates over the next five years.