ANALYSIS: Has a month of Ramaphosa saved SA from a Moody’s downgrade?
London — SA will learn soon whether Cyril Ramaphosa’s first month as president has saved the country’s last remaining investment-grade rating, but even if it hasn’t, a broader rise in optimism should limit the damage.
Moody’s, with a downgrade review on SA since November, is to make a decision by March 23.
A cut to junk — following downgrades by S&P Global Ratings and Fitch Ratings — will see the country ejected from Citi’s influential World Government Bond Index (WGBI), triggering up to R100bn in selling by foreign investors.
It is a prospect that sends a chill down the spine of officials who know the odds are not in their favour.
"It is very difficult to read the body language of the rating agencies," new Finance Minister Nhlanhla Nene said in London this week, having just meet Moody’s. "If there was a downgrade that would have a negative effect".
Moody’s rarely spares those it puts on a downgrade warning.
Only seven of the dozens of countries it has had on review over the last two years have been reprieved, its data shows. SA was one of those. None have been saved twice.
As a result, markets seem to be going with the form book.
Zsolt Papp, an emerging market debt portfolio manager at JPMorgan Asset Management points to the ‘spread’, or premium, investors demand to buy South African government bonds rather than US ones.
That spread is now 245 basis points, which is right in line with the average for ‘BB’ bracket ‘junk’-rated countries such as Macedonia and Guatemala or heavyweights like Turkey and Brazil.
"The market is already pricing SA as a BB credit," Papp said, although he said he was not sure which way the decision would go.
For a government, losing ‘investment grade’ status causes pain because it means certain types of investors — usually big pension funds or exchange-traded funds — are mandated only to buy high-grade debt. They are forced to sell any bonds which are downgraded to junk.
A 2016 World Bank study, which was co-authored by the South African Reserve Bank, found that being cut to ‘junk’ by at least two of the major ratings agencies increased a country’s treasury bill rate by almost 200 basis points on average.
SA intends to borrow a much smaller-than-usual R4.2bn in T-bills in 2018-19 but any rise in costs won’t help a debt level that has already more than doubled as a share of GDP over the last nine years.
The Moody’s blues
But there are some factors that could make SA’s experience different.
The World Bank’s analysis looked mainly at foreign currency debt downgrades, but Moody’s decision is related to the country’s domestic rand-denominated debt.
It is far more important because roughly 90% of all SA’s debt is local currency, S&P estimates. About 40% of it is held by foreigners who can be quick to flee when the outlook sours.
The World Bank didn’t detect any statistically significant effect from local currency downgrades. But it did find that the main effect — more than two-thirds of it — came when the first rating agency downgraded a credit to junk.
Market reaction to subsequent downgrades is usually far smaller, it noted.
Another potentially damage-limiting factor is widely held optimism that Ramaphosa and his new team will be able repair at least some of the damage done during Jacob Zuma’s tenure.
South African stocks, bonds and currency have all rallied hard since late 2017 when Ramaphosa seemed set to become the new party leader. The cost of insuring against a default has plunged more than 25%.
Morgan Stanley analysts point out that South African bonds are currently international investors’ top "overweight" in portfolios linked to another influential bond index, JPMorgan’s GBI-Emerging Markets.
A downgrade would have no effect on SA’s membership of the $220bn GBI-EM index, so funds tracking it could make up for some of forced selling by Citi WGBI investors.
One of the reasons SA is still so attractive is that "real" yields, which are the rate of interest its bond offers minus the country’s inflation rate, are among the highest in emerging markets.
There are also those who reckon a downgrade is no longer on the cards, given the change in leadership and crucial measures unveiled in the recent budget. This included raising the VAT rate for the first time 25 years.
At least 10 big fund managers that Reuters interviewed for this story believe a downgrade is now unlikely.
"We don’t expect Moody’s to take any action given the adjustment that we are expecting from the deficit and VAT measures proposed in the budget," said Standard Life Aberdeen portfolio manager Kevin Daly.
The budget was welcomed by the S&P and Fitch agencies but Moody’s has stayed quiet. Nene hopes, however, the agency has been persuaded, adding: "I think it is a credible story we are telling."