By Nazmeera Moola, Co-Head of SA & Africa Fixed Income, Investec Asset Management.
- Standard & Poor’s (S&P) became the first rating agency to move following President Zuma’s decision last week to remove both Finance Minister Pravin Gordhan and Deputy Finance Minister Mcebisi Jonas from his cabinet last week.
- S&P downgraded South Africa’s foreign currency rating to BB+, one notch below investment grade, and moved the local currency rating to BBB-, the lowest investment grade rating. Importantly, it retained the outlook at negative. This leaves South Africa vulnerable to a further rating downgrade in the next two years. Such a move would leave South Africa’s local currency debt below investment grade.
- S&P clearly cited the “executive changes initiated by President Zuma” as the reason for the downgrade. It sees this as putting at risk South Africa’s “fiscal and growth outcomes.” South Africa’s economy was showing signs of recovery in recent months – however the recent changes could easily derail this progress. S&P went on to say that it assesses that “contingent liabilities to the state are rising.” In simple terms, S&P sees continued deterioration in the credit worthiness of government-owned companies, notably Eskom.
- Going forward, there are several key developments to watch. These include:
- Also on Monday evening, Moody’s issued a statement saying that it was putting South Africa on negative watch for a downgrade. It would look to resolve that in the next 30-90 days. As a result, there will be no update from Moody’s on 7 April. Given current circumstances, when it does act, Moody’s is likely to move both the local and foreign currency ratings to Baa3 (equivalent to BBB- at S&P), the lowest investment grade (IG) rating on its scale. More pertinently, it could also keep the rating outlook on negative – leaving South Africa at risk of moving below IG in the foreseeable future.
- If local currency ratings for both Moody’s and S&P soon fall to below IG, South Africa would exit the Citi World Investment Grade Bond Index. We estimate that forced selling in such an instance could amount to up to R120bn.
- There is a real risk that some members of senior management at the National Treasury will resign in the coming weeks. Since 1994, the National Treasury has become a formidable institution that has provided stability for South Africa through the Asian crisis in 1998 and the global financial crisis in 2008. Institutions are only as strong as the people that lead and staff them. A significant loss of key people will undermine this institution completely.
- Market reaction to President Zuma’s reshuffle was relatively moderate last Friday and on Monday morning. This is due to two factors:
- Firstly, money is flowing into emerging market assets from around the world at this point – unlike the outflows we were seeing in December 2015 when Finance Minister Nhlanhla Nene was removed. According to Goldman Sachs, emerging market debt and equity funds registered a combined $33.9bn worth of inflows in the first quarter of 2017. This is the largest first quarter inflow on record. That moderates any sell-off.
- Secondly, there is a general expectation that the ANC will counter the cabinet reshuffle by supporting the no confidence vote in President Zuma and limit the damage. S&P’s rating downgrade already triggered another leg of the sell-off. If the ANC does not move to remove President Zuma, we could see the bond, currency and equity markets begin selling off in earnest in the coming days.
- The outlook for South Africa’s borrowing costs (as reflected by government bond yields) and the consumer inflation outlook (which is dramatically impacted by the level of the rand) will now be determined by the political outlook. The status quo is likely to lead to continued deterioration in both of these key variables.
Investec Asset Management is responsible for the investment management of R1.6 trillion of client assets globally.
Nazmeera Moola oversees the investment management of R190bn of client assets as Co-Head of SA & Africa Fixed Income at Investec Asset Management.
About Investec Asset Management
Investec Asset Management is an independently managed subsidiary of Investec Group. Investec Asset Management is a specialist investment manager, providing a premier range of products to institutional and individual investors. Established in 1991, the firm has been built from start-up into an international business managing approximately R1.6 trillion* on behalf of third party clients. The firm seeks to create a profitable partnership between clients, shareholders and employees, and to exceed expectations for both client service and performance.*As at end December 2016
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