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Moody’s downgrade collides with rally

Moody’s Investors Service cut South African government debt for the first time since the end of apartheid just as the addition of the securities to Citigroup’s benchmark index helps spur record purchases.

The one-level downgrade by Moody’s would not end the rally that had sent yields on government debt to record lows as inflows grew because of the inclusion in the World Government Bond Index (WGBI), analysts at Barclays’ Absa Capital said on Thursday.

Moodys. Credit: REUTERS

About half of the time, yields move in the opposite direction suggested by new ratings, according to data compiled by Bloomberg.

Citigroup predicts the addition will help lure as much as $8 billion (R66.2bn) to the $92bn market as funds tracking the benchmark boost holdings.

The market impact of the downgrade “will be more muted than in the absence of these flows”, Michael Grobler, a fixed-income analyst at Afrifocus Securities in Cape Town, said on Thursday.

“I would assign a very low probability that future ratings action in the next six to 12 months would put our inclusion in the WGBI at risk.

“That should probably help the bond market to digest the news relatively smoothly,” Grobler added.

Moody’s cited the government’s “reduced capacity to handle the current political and economic situation” for the reduction to Baa1, which comes after six weeks of labour unrest that has left at least 46 people dead, and shut gold, platinum and coal mines.

The company rates South African debt at the third-lowest investment grade level, the same as the BBB+ ratings assigned to the country by Fitch Ratings and Standard & Poor’s (S&P).

More than 100 000 miners and truck drivers are on strike in South Africa, the nation with the largest platinum, chrome and manganese reserves, as workers demand above-inflation pay increases.

The wildcat strikes shut about 39 percent of the country’s gold output last week after miners walked out of AngloGold Ashanti’s mines, joining workers from Gold Fields, who did the same on September 9. Mining accounts for about 9 percent of South Africa’s gross domestic product.

Recent events had heightened investors’ concerns of “socio-economic challenges, in particular the high unemployment rate”, Kristin Lindow, Moody’s sovereign analyst, said on Thursday.

South Africa’s unemployment rate of 24.9 percent is the highest of more than 60 nations tracked by Bloomberg.

Moody’s put South Africa on a negative outlook in November, followed by Fitch at the beginning of this year and S&P in March. The rating by Moody’s puts South Africa in line with Mexico, Russia and Thailand.

South Africa was addressing all of the reasons given by Moody’s for the downgrade in various government programmes, the Treasury said.

It said that the government was “committed” to raising the economy’s growth potential and competitiveness through infrastructure spending, reducing the deficit and investing in education. Citigroup attributed $1bn of a record $8.9bn of foreign purchases of South African bonds to anticipation of inclusion in the bank’s index, Leon Myburgh, a sub-Saharan strategist, said last week.

Foreign ownership of South African sovereign debt had risen to about 32 percent from 24 percent before Citigroup made the announcement in April, he said.

Funds managing $1.5 trillion to $3 trillion track the index, with South Africa holding a weighting of 0.45 percent.

Ratings on the country’s debt would have to be cut to below BBB- by S&P or Baa3 by Moody’s for it to be excluded from the gauge, Myburgh said. “From a WGBI point of view, South Africa has already been included so now the exit criteria applies,” he said.

South African debt has returned 11.6 percent in dollar terms this year, compared with 2.4 percent for the US, the EFFAS/Bloomberg indexes show.

While the downgrade was “very disappointing”, it should not have a “significantly negative impact” on South Africa’s funding costs as now Moody’s was in line with the other ratings companies, Kevin Lings, an economist at Stanlib Asset Management, said.

“The rating downgrade also occurs in a global environment of ratings downgrade, where credit rating agencies have lost credibility.”

Yields on government bonds moved in the opposite direction 47 percent of the time for Moody’s and for S&P, on 314 upgrades, downgrades and outlook changes going back as far as 38 years, according to data compiled by Bloomberg.

The data measured yields after a month relative to US Treasury debt, the global benchmark.

The cost to insure against a default on South African bonds over five years fell three basis points to 149.6, after climbing 2.8 basis points on Thursday.

A drop in the contracts indicates an improvement in risk perceptions. That compares with a five basis point drop to 148 for similar Russian contracts, a second day of declines.

Yields on South Africa’s 6.75 percent rand notes due in March 2021 fell one basis point to 6.49 percent, after rising six basis points on Thursday.

The yield premium of the benchmark debt over US Treasuries widened four basis points to 482, within nine basis points of a record low.

The rand, which weakened as much as 0.6 percent after Thursday’s cut by Moody’s, ended the day little-changed at R8.2331 to the dollar. It fell less than 0.1 percent to R8.2370 by 11.25am before it was bid at R8.2537 by 5pm on Friday.

“I don’t think the downgrade necessarily will deter investors,” Jeremy Brewin, who helps manage more than $5bn in emerging market debt at Aviva Investors in London, said.

“You have fast money and hedge funds who have taken bonds back to their price highs and yield lows.” – Stephen Gunnion, Nasreen Seria and Franz Wild from Bloomberg.

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