SA investors must pay attention to Turkey’s falling credit ratings

The erosion of Turkey’s creditworthiness is a warning signal for SA, and investors are ignoring it, according to Informa Financial Markets.

The cost of insuring the country’s debt against nonpayment dropped to the lowest in 13 months this week, even as a funding crisis at Eskom strains government finances while the economy struggles to recover from the worst quarterly contraction since the 2008 financial crisis.

Moody’s Investors Service, the only major ratings company still to assess SA at investment level, is reviewing its stance in November. In June, Moody’s cut Turkey’s rating deeper into junk, citing, among other factors, erosion of institutional strength and the government’s inability to implement measures to revive the economy. Similar problems also plague SA, said Christopher Shiells, a London-based emerging-market analyst at Informa.

“Turkey’s credit-rating troubles throw an uneasy light on SA,” Shiells said. “Moody’s rationale for downgrading Turkey should be of concern for SA watchers as these are problems that beset SA.”

SA’s economy has not expanded by more than 2% a year since 2013, and endured recessions in 2009 and 2018. There is a chance it may be headed for another after the first-quarter contraction. Turkey’s economy emerged from a recession in the first quarter.

Yet the cost of five-year credit-default swaps (CDS) — insurance against a default — fell to 163 basis points on Wednesday, more than 200 below Turkey’s. That suggests traders are not hedging for the possibility of a downgrade.

“There could be a widening out in SA spreads in the build-up to the November rating decision if economic fundamentals continue to deteriorate,” Shiells said. The CDS spread could “blow out” as much as 200 basis points in the event of a downgrade, he said.

The blow-out could extend to bonds. Benchmark government bond yields are around the lowest since April 2018, leaving plenty of scope for a reversal in the event of a Moody’s downgrade, which would spark a sell-off by funds that track investment-grade indexes.

And while the country’s foreign-currency debt is already considered junk — with ratings below investment level at S&P Global Ratings and Fitch Ratings — that has not deterred investors. The bonds have returned 12.3% in 2019, beating the average return of 11% for the 629 member Bloomberg Barclays EM Hard Currency Aggregate Sovereign Total Return Index. The country’s 2,048 securities are the top performers in BB category, with a return of 20%. The yield on the debt is at the lowest since the notes began trading in May 2018.

A downgrade for the local-currency bonds to junk would have a “spillover” effect on the hard-currency notes, said Trieu Pham, a London-based emerging markets strategist at ING Bank.

“With the external backdrop dominating, market pricing indeed doesn’t factor in the risk of a Moody’s downgrade,” Pham said. “A negative surprise would see an initial knee jerk reaction on the bonds.’’

SA’s currency, too, shows little sign of investor anxiety, with the premium of options to sell the rand versus the dollar over those to buy it at the lowest level since May 2018. That may haunt some traders come November.

Bloomberg