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SA downgrade likely to trigger more volatility - expert

Nov 27 2017 05:00
Carin Smith

Cape Town - Friday's ratings downgrade of SA is likely to trigger more volatility, according to Gavin Smith, head of Africa at financial advisory group deVere Acuma.
 
In his view, all eyes will be on the rand, South African banking shares and bond yields.
 
“Markets loathe uncertainty and they typically respond to it with volatility. It can be expected that there will be market turbulence ahead,” he said.
 
In his view, foreign investors are likely to reduce their exposure to South African markets, which could result in a sell-off in the South African equity and bond markets, putting prices and yields under pressure.
 
“The longer-term effects will depend largely on how government reacts to the downgrade and with the ANC leadership conference next month, uncertainty will be at an all-time high,” said Smith.
 
“We want to emphasise that investors should not react emotionally to the downgrade, as history has shown - even in situations like this - that a long-term strategy linked to the levels of risk and outcome that investors aim for still remains the best investment strategy.”

Tumisho Grater, economic strategist at Novare Actuaries and Consultants, explained that S&P’s downgrade means that South Africa will now fall out of the Barclays Global Aggregate Index (BGAI).

While outflows are anticipated, they are not likely to be as large as what may be expected should South Africa fall out of the Citi’s World Government Bond Index (WGBI) - which requires both Moody’s and S&P’s long-term local currency rating to be below investment grade before removing a country from the index - Grater explained.

"The slip in the credit ratings increases the calls for reforms even louder and falling deeper into the red," she said.

She added that earlier this year, South Africa fell out of the J.P. Morgan Emerging Markets Index following the downgrades that occurred after the Cabinet reshuffle.

"Before the global financial crisis (GFC), non-residents held about 7% of domestic currency government debt. This ratio increased to current levels of around 40%. This is a positive development and is reflective of South Africa’s deep and liquid domestic bond market," said Grater.

"However, the concern is that the increased holdings make South Africa more vulnerable to changes in non-resident sentiment. Sub-investment grade credit rating - and in this instance on the local denominated sovereign debt - prevents many institutional investors from holding South African bonds, resulting in capital outflows."

In her view, the short-term impact will also depend on how much is already priced into the markets, the extent to which positions have already been reduced and whether the buyers of these bonds are residents or non-residents.

Sanisha Packirisamy of Momentum Investments, pointed out that all three ratings agencies suggest a further disappointment on growth or fiscal outcomes could trigger additional negative ratings action.

"In contrast, all three agencies commended SA on its monetary flexibility, deep capital markets and improving external position," she added.

In Packirisamy's view, SA's ratings outlook cold take on a more positive bias should the new leadership ushered in at the December ANC elective conference boost confidence by implementing structural reforms.

"However, if structural reforms are not forthcoming and if offsetting fiscal measures in the February 2018 national budget do not stabilise SA's fiscal and debt outlook, further negative ratings action is more than likely by Fitch and Moody's in particular," she cautioned.

Karl Westvig, CEO, Retail Capital, said without access to credit and a higher cost thereof, efforts to increase small business participation in key sectors of the economy will be negated, while a weaker rand will rule out any hope of lower interest rates in the foreseeable future.

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sa economy  |  downgrades  |  ratings agencies
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