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How being downgraded has affected countries around the world

May 18 2017 21:00

Cape Town – South African and overseas investors seem to have become used to the idea that adverse events, such as President Jacob Zuma’s Cabinet reshuffle and the subsequent ratings downgrades, create opportunities, according to Johan Louwrens, research and investment analyst at Glacier by Sanlam. 

“We have also seen that the anticipation of an event, just like mentally preparing yourself for a flu shot, is worse than the actual occurrence of that event. Government bond yields and exchange rates are an excellent way to gauge the market’s sentiment towards a country.” 

South Africans have faced many ups and downs in the market, says Louwrens. “We have seen finance ministers come and go, and had an overnight Cabinet reshuffle. Now we face yet another challenge; our sovereign credit rating has dropped below investment grade – so what now?” 

READ: Political risk? Bring it on, say investors in SA debt

Louwrens takes a look at a number of scenarios covering a spectrum of outcomes to see where South Africa fits in. 

Brazil

Like South Africa, Brazil has also suffered from political instability. When fear and anticipation hits the market, as it did in the middle of 2015 when Standard & Poor's changed the status of Brazil’s sovereign credit rating outlook to “negative”, the demand for the government’s ten-year bonds dropped. 

“This pushed the yield from approximately 13.5%, to an eye-watering 16.9%. The currency followed suit, depreciating by approximately 15.5% against the dollar in approximately the same period of time - this without even being downgraded,” Louwrens says. 

Expectations were cemented, and the market priced in the more than likely possibility of a downgrade. On September 9 2015, as the market expected, Brazil took the plunge from investment grade to junk status (a move from BBB- to BB+ in S&P talk).

READ: Brazil economy shrinks more than economists forecast 

“What happened next was surprising - the market shrugged it off. It was almost as if the market had predicted the worst case scenario, priced the risk accordingly, and then pro-actively managed this risk before it even came to fruition,” Louwrens says. 

Brazil isn’t, however, the only economy to have suffered a similar fate (even though Brazilian investors were rewarded handsomely after the impeachment of Dilma Rousseff), as the same pricing mechanism can be seen in countries like Russia, Greece, and even in South Africa.

Nenegate

The unanticipated shock of Nenegate (December 9 2015) had an extreme effect on the South African 10-year government yield and the rand/dollar exchange rate (surpassing the negative outlook woes which took place a few days prior). 

“The yield peaked at approximately 10.3%, a far cry from its typical 7% to 9% range,” Louwrens says.

This, however, managed to recover relatively quickly in the grander scheme of things, normalising in the span of a few months.

Rating agencies were, however, keeping a close eye on South Africa post-Nenegate, and after the Cabinet reshuffle on March 30 2017, which saw Pravin Gordhan and Mcebisi Jonas removed from the finance ministry, the market had already priced in the risk of a downgrade. 

READ: Fitch downgrade is no surprise - analyst 

The downgrade finally came to fruition on April 3 2017 when S&P downgraded the country to junk status. Fitch Ratings followed suit on April 7. 

Greece

"Let’s start by discussing the worst-case scenario – Greece. The country was (and still is) in a precarious position, with a current debt to GDP of 179% (anything above 60% is seen as worrisome)," Louwrens says.

“The usual counter-measures used to fight a crumbling economy were somewhat muted due to the single currency and the inability to apply succinct monetary policy. As luck would have it, South Africa is not at that level yet, even though we are reaching levels which have raised a few eyebrows.”

Russia  

Russia’s equity market has proven to be a more resilient entity, managing to creep upwards despite currency hardships, and country invasions. It managed to climb about 15% per annum over two years since being downgraded - hardly a catastrophic failure. 

Where does this leave SA investors?

The most important thing investors can do in these uncertain times, Louwrens says, is to remain calm, stick to long-term investment plans and not do anything rash. Hasty decisions could potentially do more harm than good. 

“All hope is not lost. We haven’t reached a point where we as investors need to throw in the towel and wave a white flag. The anticipation of an event tends to drive markets, and ultimately, these fears get priced in rapidly and dissipate at almost the same pace.” 

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bonds  |  opinion  |  sa economy  |  markets

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