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Johannesburg – Ratings agencies Standard & Poor’s (S&P) and Fitch recently downgraded South Africa’s sovereign rating to sub-investment grade and Moody’s has placed the country on review for a downgrade.
Dave Mohr, chief investment strategist and Izak Odendaal, Investment Strategist at Old Mutual Multi-Managers share insights on the impact of the downgrade to junk status.
Market reaction
The market reaction was “unpleasant”, but within the expected range of volatility, Mohr and Odendaal explained in a report. A diversified portfolio would have performed “reasonably well” over this tumultuous period, they said.
The 10-year government bond yield rallied to a 16-month low of 8.3%, but then rose to 9% following the downgrade. This is at the same level it was at the beginning of the year. The year-to-date return of the All Bond Index has been cut to 2%. It is still the leading asset class available to domestic investors, returning 11% over the past 12 months, explained Mohr and Odendaal.
The rand essentially declined 10% from R12.30/$ to R13.80/$, following the political events such as former finance minister Pravin Gordhan being recalled from an investment roadshow and the subsequent Cabinet reshuffle. The rand’s reaction was expected to be worse.
“It is clear that a lot of political risk had already been priced into the rand and South Africa’s bonds prior to the recent developments.” The rand is still 9% stronger against the US dollar than a year ago.
READ: Rand heading for R14/$ on second downgrade
Local equities also held up. Interest rate-sensitive shares have fallen and the four major banks were hardest hit, having lost over R80bn or 11% of their share value. S&P downgraded local banks as they cannot be rated higher than the country's foreign currency sovereign credit rating. The South African Reserve Bank (Sarb) issued a statement in support of the banks, saying that they were well-capitalised to deal with the effects of the downgrade.
Rand outlook influenced by global factors
Mohr and Odendaal pointed out that the rand was impacted equally by international events as it was by domestic developments. They added that a weaker rand has benefits and costs. The cost would come through on higher import prices. In turn the rand could support export revenues and foreign investment income.
JSE well positioned
The JSE All Share provides currency diversification because it is a global index. Also, the All Share has moved sideways for almost three years, and earnings growth is expected to pick up.
Further, in dollar terms, the JSE has been flat for 10 years indicating that a weaker rand has been beneficial, explained Mohr and Odendaal. The average annual real return since the 1960s is 8%. Since 1995, local equities outperformed global equities by 1% per year (in rand terms). This is despite the depreciation of the rand against the dollar over this period.
Outlook for bonds
“If investors lose faith in Government’s commitment to the fiscal targets set out in the February Budget, bonds could come under pressure,” said Mohr and Odendaal.
The downgrade could become a major problem if South Africa loses its local currency investment grade status.
ALSO READ: No need to be despondent after downgrade – Gigaba
Treasury previously highlighted that S&P’s downgrade was for foreign currency-denominated debt, and rand denominated debt which made 90% of the debt portfolio remains investment grade.
Mohr and Odendaal added that inflation has a great bearing on the bond market and that the SARB’s commitment to the inflation target was a positive. “S&P still rates monetary policy independence as a sign of strength.”
They added that political and downgrade risks are also largely priced in the bond returns.
Business and consumer confidence
The biggest immediate impact of the ratings downgrade is likely to be on confidence, said Mohr and Odendaal.
“To invest or expand, businesses must feel confident about the future. Similarly, to make big ticket purchases, households need to feel financially secure.” The ratings downgrade and uncertain political environment is likely to continue weighing on sentiment.
READ: Junk status: Hard times ahead for consumers
Business confidence will likely take the biggest hit, due to “heightened political uncertainty”. This will result in fixed investment contracting further and ultimately the shedding of jobs, said Mamello Matikinca, FNB economist.
She told Fin24 that consumers are likely to be bearish going forward.
