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No turning point yet for rand, SA assets - researcher

Apr 07 2017 18:55
Liesl Peyper

Cape Town – The decision of Standard & Poor’s (S&P) Global Ratings and Fitch to slash South Africa’s sovereign credit rating to junk is unlikely to signal that the worst is over for South Africa and that the rand could regain lost ground. 

Adriaan du Toit from Citi Research said in a company note on Friday that based on the experience of some of South Africa’s emerging market peers that have recently been downgraded to sub-investment grade, there may be conclusions that a country’s currency could regain some ground, following a downgrade. 

“We suspect that this is the way that many investors have been interpreting the events unfolding in South Africa over the past two weeks, in other words that the ‘worst’ has happened, political power has shifted and that the rand are therefore beginning to regain ground.”

Du Toit cited the acceleration of foreign bond buying as an example of this. "With foreign bond buying accelerating as the political temperate increased (R19bn inflow of the past two weeks), South African government bonds remained relatively well supported."

READ: Net foreign bond buying jumps amid Gordhan removal 

“[But] we are a bit cautious about the idea that the ‘worst’ point has been reached,” he added. Du Toit added that political power in his view hasn’t shifted enough to justify “outright bullishness”. 

“Stated differently, South African rand asset valuations are not quite aligned with recent political developments and risks.” 

Trickle-down effect of ratings downgrades

“[There] seems to be momentum behind the negative ratings trajectory and we think it’s important to bear in mind that adverse ratings actions will trickle down to state-owned enterprises (SOEs) and more downgrades could lead to jitters about index expulsions,” Du Toit said.

Fitch’s decision to downgrade South Africa on Friday – the second in a matter of one week – won’t trigger South Africa’s immediate expulsion from the World Government Bond Index. 

For that to happen, Moody’s (which currently has South Africa on a Baa2-rating at investment grade) will have to cut its rating by two notches to BA1 (sub-investment grade in Moody’s terms).

READ: Rand gains as Moody's delays SA's credit rating 

On Tuesday, Moody’s said in a statement that it decided to defer its decision on South Africa's sovereign credit rating. Moody’s initially planned to review South Africa's credit rating, with an announcement expected on Friday. 

It said its review of South Africa typically takes between 30 and 90 days after which a decision will be announced. 

What expulsion means

Du Toit was of the view that a credit-related expulsion from the World Government Bond Index is not an “imminent threat”. 

“But it is important to note that removal occurs immediately after the fixing date when the local currency rating falls below investment grade by both S&P and Moody’s.” 

Du Toit said there are two examples of credit-related expulsions from the World Government Index – Greece in July 2010 and Portugal in February 2012. 

“There were of course a number of issues that contributed to the downgrades which ultimately led to the expulsion and it’s again important to not assign all of the price action to credit downgrades per se.” 

In the case of Greece, for example, the negative effect as a result of the index expulsion was “negligible” compared to asset price weakness that followed a year later, Du Toit said. 

READ: To expect rand recovery would be 'foolish' - analyst

He concluded that although the rand and South African government bonds have started to react to a “new” reality, South African assets could still underperform. 

“It is clear from other countries that political shifts, credit rating downgrades, and/or index expulsions could represent a turning point for foreign currency trading and rates. We are not convinced that the point has been reached in South Africa yet.” 

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