EDITORIAL: Slow poison of downgrades
The City of Johannesburg forced to approach the Development Bank of SA for funding as investor interest sours
Speaking on a panel at Wits Business School this week, Johannesburg’s the mayoral committee member for finance Rabelani Dagada revealed that the city, which has a debt book of about R17bn, had been hoping to raise about R2.5bn on the market after an investor road show late in 2016 but that there had been no appetite for it. In the end, the city approached the Development Bank of SA for the funding it needed, most of which was for investment in much-needed maintenance and repairs of existing infrastructure as well as in new infrastructure.
The City of Johannesburg has not even been downgraded yet: it is rated only by Moody’s, as are some of SA’s other large metros. Moody’s has all of them on review for a downgrade, with the sovereign. Meanwhile, though, even the expectation of a downgrade has damped the appetite of bond market investors and other lenders for municipal debt — and no doubt raised the cost of that debt.
It is a story that is playing out across the market, following the first of the downgrades to junk status by S&P Global Ratings and Fitch two weeks ago. Three corporate bond issues have been postponed. The South African National Roads Agency, which needs to raise R200m, has delayed its return to the bond market. Transnet raised only R20m of a planned R200m when it issued on April 10.
It speaks to the effect of the downgrades we have already seen, and those we are yet to see. The surprising resilience of the rand and of bond yields has helped to mask the seriousness of the downgrades and make it too easy to dismiss them.
But no one should be fooled about just how bad this could be, not just for financial markets, but for SA’s already ailing real economy. We have been lucky in that the downgrades came at a time when global conditions are very favourable for emerging markets.
The shock of the recall of the former finance minister from his investor road show just over three weeks ago and of the downgrades two weeks ago hit when the rand and bond yields were at new highs — and in an environment in which they could bounce back, as the rand and bond yields did by Thursday when they lifted to three-week bests of R13.19 and 8.78%, respectively.
The rand’s strength is not that surprising — high-yield emerging markets are in vogue, SA is far from being a basket case and its bond yields are now increasingly attractive to international investors who are buying in.
We have not yet even seen the first tranche of the forced selling by international bond-market investors that will come at the end of May
But that is for now.
It is still early days. We have not yet even seen the first tranche of the forced selling by international bond-market investors that will come at the end of May when about $1bn in outflows linked to the JP Morgan index is expected following the Fitch downgrade.
But Moody’s decision and S&P’s June review are yet to come and if SA’s local currency rating were to be junked by those agencies, we would be booted out of the key Citi World Government Bond Index and other benchmarks, triggering an estimated R100bn-R120bn in forced selling by international investors and almost certainly crashing the rand. It might be less bad if the emerging market tide were still coming in. But it could be very bad when that emerging market tide goes out, as it inevitably will, and the effect on SA’s inflation, interest rates and growth could be severe.
Meanwhile, the effect in terms of availability and cost is clearly already being felt by those looking to issue debt on the market. And the more government and companies, public or private, have to pay to borrow, the less there is to spend on other more productive goods and services.
It could be a long hard road ahead unless SA stops just trying to talk the market back up and instead takes real, tough action to reform the economy and avert further downgrades.