Downgrading creates threat to SA bonds
JOHANNESBURG – South African bonds are facing heightened volatility over the new year if the economy is downgraded by rating agencies to junk status.
Ratings agency S&P Global last week reviewed South Africa’s outlook from stable to negative, citing the rapid worsening of the country's debt metrics, low gross domestic product growth and high fiscal deficits.
Moody’s also lowered South Africa’s outlook on its investment-grade rating to negative last month, effectively giving the country until the February 2020 Budget to fix its fiscal metrics.
This downward trend may trigger a bonds sell-off by credit-sensitive investors and further uncertainty from active fund managers about risk-free assets.
The bond market is a good indication of the health of a country's economy.
Independent analyst Cedrick Pila said yesterday that the negative outlook and sentiment shared by the major ratings agencies was disconcerting.
Pila said unit trust funds tracking the World Government Bond Index (WGBI), or who can only hold investment-grade bonds, would be forced to sell if South Africa falls out of the index as a result of a credit ratings downgrade.
“However, given the higher yields that would be on offer, new investors would come into the market. I doubt that the inflows would offset the sharp sell-off though in the event of a downgrade,” Pila said. “As long as we do not get downgraded, our bonds will see much of the same 2019 trade volumes in 2020. Our bonds are the highest yielding bonds in the WGBI, so it becomes difficult not to own them and expensive to short them.”
The government successfully placed $5 billion (R73.5bn) in 10- and 30-year bonds in the international capital markets in September 2019.
Pila said if domestic bonds fell out of major bond indices, foreign institutional investors who were restricted by their mandates to invest in bonds outside of these indexes, would have to sell these bonds and new capital would be restricted.
All this negative movement and market volatility could lead to individual investors being wary of lending money to the government if the economy was in the red. But head of investments at 10X Investments, Chris Eddy, said individual investors should not panic if they were invested in well-diversified portfolios.
Eddy said a high equity balanced portfolio would typically have 45 to 50 percent in South African equity, of which more than half was rand hedge and 25 to 30 percent directly offshore, meaning that more than 50 percent of the portfolio should perform well when the rand depreciates.
He said this was what happened when S&P downgraded South African government debt to sub-investment grade in 2017, as well as over the recent medium-term budget, and subsequent ratings outlook change by Moody’s