JOHANNESBURG - Well, well, well, is it not interesting? S&P Global Ratings decision to lower South Africa’s ratings resulted in the country falling out of the Barclays Global (bond) Aggregate Index, which means that according to RMB Morgan Stanley approximately $1.5 billion, or R21bn at an exchange rate of R14 to the US dollar, will be sold back into the market.
Is it incidental that the JSE recorded that, since the end of September up to the downgrade announcement, foreign investors were net sellers of South African bonds to the value of approximately R20bn?
Yes, a possible downgrade was well telegraphed since the finance minister’s medium-term budget speech, but this was too close for comfort.
As alluded to in previous articles, similar patterns were evident in the downgrades of Brazil and Russia.
As expected “sell the rumour, buy the fact” again repeated itself. When the markets opened this week foreigners turned net buyers of South African bonds while the rand recovered strongly. The longer-term outlook for long-dated bonds are cloudy, to say the least.
On the economic front, the equity market is telling us that economic growth in the third quarter was in the region of 1percent and has accelerated to about 2percent in the current quarter.
The recently published Ifo World Economic Survey indicated that the economic climate in South Africa is still negative but is improving while economic expectations are improving.
Although business confidence levels as measured by the business and consumer confidence index are unchanged from a year ago, empirical evidence suggests that in normal circumstances business confidence would have been approximately 5percent higher.
Uncertainties
With business confidence a leading indicator for South Africa’s credit rating, the normalisation of business confidence is critical going forward. Therefore the uncertainties regarding political leadership, state-owned enterprises and fiscal discipline should be removed.
All the bad news or most of it is in the public domain and can and should be addressed.
The SA Reserve Bank’s Monetary Policy Committee (MPC) probably toed the line to appease the rating agencies by keeping rates on hold, but this did not prevent S&P from cutting our credit rating.
Improved consumer sentiment will be a major boost to business confidence and one has to agree with Cosatu’s view that the MPC’s decision was a missed opportunity to “initiate some positive economic sentiment”.
Stronger economic growth leads to higher tax collections and lower budget deficits, period.
If the uncertainties, as mentioned, are not dealt with without hesitation, the other two credit rating agencies, Moody’s and Fitch, are likely to downgrade our debt and currency as well.
South Africa’s 10-year government bond yield spread to US treasuries, adjusted for inflation differentials, is likely to join the Brics curve at a higher level. That will effectively mean that the bond yield spread to US treasuries will move more than 100 basis points higher from the current level of 4percent.
In fact, it may even reach Brazil’s level of 7percent or 300 basis points higher on a Moody’s downgrade as South Africa will fall out of the Citi World Global Aggregate Bond Index.
According to RMB Morgan Stanley, $5bn or R70bn at an exchange rate of R14 to the US dollar will be sold back into the market. The damage can be far worse as the rand will bear the brunt of the sales.
Moody’s review period for a downgrade runs until the 2018 Budget is known in February. Moody’s thereby has effectively given South Africa 90 days to do the right thing, otherwise the economy may suffer a major implosion. Lending rates will soar and unemployment will reach unprecedented levels. There will be no turning back as the onus is now squarely on the policymakers’ shoulders.
The winding down of the European Central Bank’s large-scale bond-buying programme and the eventual ceasing of such activities in 2018 are also likely to exert upward pressure on long-dated bonds in especially the Brics countries later in the year as the gap between the Brics and Eurozone yield spread curves will narrow.
Ryk de Klerk was co-founder of PlexCrown Fund Ratings and is currently a consultant for PlexCrown Fund Ratings.
The views expressed here are not necessarily those of Independent Media.