London - If South Africa loses two of its
prized investment grade credit ratings for foreign and local
currency borrowing in the turmoil triggered by the sacking of
the finance minister, the country could lose more than $10
billion in investment funds.
S&P Global has already struck. In an unscheduled review on
Monday that prompted a selloff in South African assets, it cut
the sovereign rating for external debt to BB+, one notch below
investment grade - or "junk" status in market parlance.
It cited the impact of the divisions in government that led
to Pravin Gordhan's removal.
Moody's later placed South Africa on review for downgrade.
A third major international ratings
firm Fitch warned that President Jacob Zuma's shake-up
intensified political risk and signalled policy changes that
could undermine its credit score.
Being downgraded to junk by at least two agencies will see
South Africa drop out of some widely used global bond indexes
that rely on investment grades only and force international
funds who track these or who are prohibited from holding
sub-investment grade securities to sell.
"The problem has just started in South Africa - there was a
lot of complacency on the ratings shift," said Salman Ahmed,
chief global strategist at Lombard Odier.
Read also: S&P first to give SA 'junk' rating
The prospect of such a demotion is more imminent for hard
currency debt, where Fitch's standing rating is just one notch
above junk. The Moody's rating is two rungs above.
But a bigger impact on the country's access to funds could
come if two of the three agencies also demoninate the
rand-denominated government debt as sub-investment grade. S&P's
local currency rating is just one level above junk as well, with
Moody's two notches above.
So far, only one of the six ratings - three for sovereign
debt and three for local - from the major international ratings
agencies has slipped into junk.
JPMorgan - which compiles some of the most widely used
emerging market debt indexes - estimates that a junk rating for
South Africa's mostly dollar-denominated foreign currency
Eurobonds could see forced selling of up to $2.4 billion.
Roughly half the total would come from funds dedicated to
investment grade emerging market debt, the other half from
global investment grade bond funds, JPMorgan said, adding this
was much less than the forced selling risk the bank had ascribed
in recent years to Brazil at $6 billion or Turkey at $7 billion.
"The more modest figure for South Africa is explained by the
smaller bond stock, and therefore smaller weights particularly
in widely used global bond indexes, coupled with an underweight
positioning by investors," the bank said.
Local danger
Yet South Africa's outstanding $14.6 billion hard-currency
debt is just a 10th of total public government debt, with local
sovereign bonds tallying up to 1.722 trillion rand ($125
billion), according to data from the National Treasury.
For UBS, the real danger lies in local bond markets. In a
note this week, UBS estimated some $10 billion of South African
bond holdings are indexed to Citi's World Government Bond Index
(WGBI), tracked by $3 trillion worldwide.
JPMorgan, which compiles the GBI-EM IG-only index, said it
estimated that a downgrade of local currency debt could lead to
total index-related selling of as much as $8.5 billion.
Inclusion in both indexes hinges on investment grade ratings
on local debt from both Moody's and S&P Global. Whle a formal
index exclusion could take up to a year, many funds would likely
exit the debt in advance.
Read also: Moody's places SA on review
Partially offsetting that hit is the fact that countries
which find themselves downgraded to junk - so-called "fallen
angels" - often draw in a different investor base seeking higher
yields and more speculative investments, said Nafez Zouk, senior
economist at Oxford Economics.
In other words, these fallen credits become bigger fish in
smaller ponds.
Some dedicated emerging market fund managers are waiting for
those opportunities.
"[South Africa's] trajectory is quite negative and is likely
to continue to be negative until we see renewal in South African
politics which could be a few years from now," said Jan Dehn at
emerging market fund manager Ashmore Investment Management.
"Even in a gradually deteriorating credit like South Africa,
asset prices can move into oversold territory relative to the
risk ... If prices fall enough that the credit has been oversold
relative to how risky it is, then clearly that’s a buying
opportunity."