While SA’s risk of a credit rating downgrade by Moody’s Investors Service is heightened, the country could be “insulated” from the expected losses, according to the Reserve Bank.

SA had a reprieve from Moody’s at the end of March when it did not make a pronouncement on the country. However, SA’s domestic fiscal position has weakened significantly, “exacerbated by, among other things, weak domestic growth; a poor revenue outlook' deteriorating debt dynamics; and the fragile financial position of state-owned enterprises”, the Bank said in its financial stability review released on Wednesday evening.

In particular, funding pressures from embattled power utility Eskom have led to higher public-sector borrowing requirements.

“This could increase the risk of a sovereign credit rating downgrade to sub-investment grade by Moody’s,” the Bank said.

A ratings downgrade from Moody’s, the last major ratings agency that has SA on investment grade, would see SA as fall out of key indices such as the Citi world government bond index (WGBI), prompting some forced selling by investors who trade the index. According to the Bank’s estimates, a downgrade could prompt forced outflows of $1.5bn or about 0.5% of GDP.

However, losses to SA’s financial markets could be limited by mitigating factors, the Bank said. These include attractive 10-year bond yields, which imply that active funds are able to take on non-investment grade exposure. Easing portfolio investments in SA seems to have been driven by institutional investors, while retail-oriented funds sold off aggressively in 2013.

“Institutional investors tend to exhibit more stable and less momentum-driven behaviour given their medium- to long-term strategies, resulting in less pro-cyclicality in the behaviour of portfolio flows,” the Bank said, adding that net portfolio outflows have always been less than estimated.

“This is because a large portion of selling tends to occur prior to the actual downgrade to sub-investment grade, and the investors with sub-investment grade mandates tend to purchase these securities, helping offset some of the flows.”

As at December 2018, non-resident holding of bonds declined to 37.7% from a “peak” of 42.8% in March after SA exited the JPMorgan global bond index and the Barclays global aggregate following downgrades to junk status from both Fitch Ratings and S&P Global Ratings, as well as the emerging-market sell-off triggered by turmoil in Turkey and Argentina.

For the year to date, non-residents have continued to sell bonds and equities “highlighting increased concerns about domestic challenges”, which has seen SA underperform against its emerging-market peers, which have mostly seen portfolio inflows.

This follows a report from Moody’s last week that warned the country’s debt is set to balloon well above levels forecast by the government and that a failure to boost growth, curtail spending and improve tax collection will “put downward pressure on the country’s rating”.

SA’s debt is rated at Baa3 by the agency, one notch above junk status, with a stable outlook. Moody’s next scheduled announcement is November 1.​