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What S&P downgrade means for SA

Apr 04 2017 12:56
Robert Brand and Paul Wallace, Bloomberg

Cape Town - South Africa’s investment-grade credit status hangs by a thread after S&P Global Ratings cut the country’s debt to junk and Moody’s Investors Service placed it on review for a downgrade.

The state of play

S&P now rates SA’s foreign-currency debt BB+, one level below investment grade, with a negative outlook. Fitch Ratings and Moody’s assess the nation’s creditworthiness at BBB- and Baa2, one and two levels above sub-investment, respectively. Both have a negative outlook, meaning they’re more likely to lower than raise the credit score.

At the same time, S&P reduced its rating for the nation’s local debt one step to BBB-, the lowest investment grade. Moody’s rates the local-currency debt at Baa2, two levels above junk, while Fitch’s assessment is BBB-, one rung above junk.

What happens next?

A one-step downgrade of the foreign-currency debt by Moody’s wouldn’t change the picture substantially, as SA would still be left with two investment-level ratings. A two-notch downgrade by Moody’s or a cut by Fitch would spark forced selling of foreign-currency bonds by investors that track investment-grade debt indexes.

On the local-currency front, it would require a one-step downgrade by Fitch and a two-notch cut by Moody’s, or another by S&P, to trigger forced selling from local-currency bond-index tracker funds. There is less danger of that happening immediately.

READ: Economist slams Treasury response to downgrade

Why does it matter?

Bond indices compiled by Bloomberg Barclays, JPMorgan Chase & Co and Citigroup, which are tracked by more than $2trn of institutional funds, have rules relating to the credit quality of constituents. Broadly speaking, those rules require an investment-grade rating, either from S&P - in the case of Citigroup’s World Government Bond Index (WGBI) - or from two of the three companies - in the case of the Bloomberg Barclays and JPMorgan emerging-market indicess.

Hard-currency indices, such as the Bloomberg Barclays Global Aggregate Index and JP Morgan’s EMBIG gauges, look at the long-term foreign-currency ratings, while local-currency indices like the WGBI focus on the local-currency rating.

Should SA lose its membership of these indices, funds that track them would be forced to sell their holdings of SA bonds. In addition, funds that are mandated to hold investment-grade debt only would be forced to sell.

What’s at stake?

Foreign investors hold 36% of SA’s R1.74trn of local-currency government bonds, according to the National Treasury’s February Budget Review. That means an amount of R623bn is potentially at risk in a selloff, in addition to about $16bn of debt denominated in foreign currencies. Foreign-currency bonds account for about 10% of SA’s total government debt of R2.2trn.

In practice, the amounts will probably be less. UBS estimates that WGBI-tracking funds account for about 22% of non-resident bond holdings, or about $10bn of SA local-currency debt, roughly the same amount as the current-account deficit. A forced sell-off by funds tracking the gauge could double the shortfall in nominal terms.

READ: Downgrade: Our people will be worse off - CEOs

What are the precedents?

Turkish and Brazilian bonds fell after they were first downgraded to junk, in September 2016 and September 2015, respectively. Turkish local government debt lost 5.1% in the month after the nation was cut to Ba1 by Moody’s, the worst performance among 31 emerging markets monitored by Bloomberg.

Its Eurobonds lost 2.4%, more than three times the average for developing-nation dollar notes in that period. Brazilian real-denominated government bonds dropped 0.73% in the four weeks after S&P moved it to BB+, while emerging-market local government bonds gained 2.7% on average.

By contrast, Russia’s assets outperformed after it was first cut to junk by S&P in January 2015. The country’s local debt and Eurobonds gained in the following month, while those of its emerging-market peers fell.

Read Fin24's top stories trending on Twitter:

s&p  |  ratings agencies  |  downgrade  |  sa economy
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