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SA ratings review

  • Overview

    S&P’s main concern remains the weak growth outlook

    By Nazmeera Moola, Co-Head of SA & Africa Fixed Income, 5 December 2016

     

    At its December 2016 update, S&P lowered South Africa’s local currency debt rating one notch to BBB (two notches above junk), while preserving the foreign currency rating at BBB- (the lowest investment-grade rating). It retained the negative outlook.

    The reasons cited for the one notch decline in the local currency rating were the decline in fiscal flexibility and the fall in the tradability of the rand. Going forward, S&P noted that it would downgrade the credit rating if:

    1. The growth or fiscal trajectories disappoint,
    2. Institutions weaken, or
    3. Net government debt or the contingent liabilities (from the state-owned enterprises) increase more than expected. The last is a change from June, when S&P had specified that debt plus contingent liabilities should not exceed 60% of GDP.

    On the positive side, S&P gave South Africa credit for strong and transparent institutions, including the judiciary and central bank, its deep financial markets and government’s commitment to fiscal consolidation.

    Its main concern is the weak growth outlook. S&P cited that political infighting was hurting confidence, and thus hampering growth. As the negative outlook was imposed in December 2015, S&P has until December 2017 to resolve this – either by downgrading South Africa’s debt rating or by moving the outlook to neutral.

    While much of the focus has been on the foreign currency rating, the biggest impact of any downgrade of this rating would be on sentiment. Only about 10% of South African government debt is in hard currency; therefore, the bulk of foreign investment in SA debt is in rand-denominated debt. Hence, the local currency rating is a far bigger determinant of flows. Specifically, we estimate that around R50-80bn of money in South Africa at the moment tracks the Citigroup World Government Bond Index (WGBI), which measures the performance of investment-grade sovereign bonds. However, only if both Moody’s and S&P downgraded South Africa’s local currency debt by two notches each would it force outflows of funds that track the WGBI. This provides a significant buffer.

     

    SA ratings Foreign LT debt Local LT debt Outlook
    S&P BBB- BBB Negative
    Moody’s Baa2 Baa2 Negative
    Fitch BBB- BBB- Negative
    R&I BBB+ A- Negative
    Dagong Global BBB+ A- Negative

     

    Source: Investec Asset Management and Bloomberg, 2.12.16.

     




    Some breathing space after Fitch and Moody’s rating review

    By Nazmeera Moola, Co-Head of SA & Africa Fixed Income, 28 November 2016

     

    There were three key announcements on Friday evening from the rating agencies on South Africa:

    1. Fitch downgraded the sovereign outlook to negative. It kept the rating for local currency (LC) and hard currency (HC) debt at BBB-.
    2. Moody’s kept the sovereign rating unchanged for both LC and HC at Baa2 (equivalent to BBB) with a negative outlook (full rating table below).
    3. S&P downgraded Eskom’s rating to BB.

     

    Fitch:

    1. Fitch downgraded the outlook to negative, but kept the rating unchanged at BBB- for both the foreign & local currency rating. Their main points of concern going forward are:
      1. Political risks to standards of governance and policymaking; ANC infighting that distracts policymakers and leads to mixed messages, thus undermining the investment climate; the lack of progress at state-owned enterprises
      2. Growth does not improve as it has forecast to 1.3% in 2017 and 2.1% in 2018
      3. An inability to stabilise the debt ratio due to weak growth and lower than expected tax revenues
      The positives Fitch noted were:
      1. A very favourable debt structure, with 90.7% of debt denominated in local currency and an average maturity of 14.6 years
      2. The adherence to the expenditure ceilings since they were introduced in 2012
      3. A positive net international investment position
      4. The shrinking current account deficit (though the South African Reserve Bank noted that the deficit expanded in 3Q16 from the 3.1% recorded in 2Q16)
      5. A strong banking sector, where capital adequacy increased to 15.5% in September 2016

     

    Moody’s:

    1. Moody’s kept South Africa’s rating unchanged at Baa2 (equivalent to BBB) for both the foreign and local currency rating, with a negative outlook. Their main points of concern going forward are:
      1. Protracted political infighting that generates policy uncertainty and impedes structural reforms
      2. Low growth reflecting persistent structural bottlenecks on top of the weak global environment
      3. An accumulation of public debt and government contingent liabilities linked to financially weak state-owned enterprises
      4. High and persistent unemployment, especially among youth, depletes human capital and increases the potential for extended protests
      The positives Moody’s noted were:
      1. Deep and well-developed domestic financial markets and a well-capitalised banking sector
      2. Accountability and independence of key institutions such as the judiciary, the Reserve Bank and the National Treasury
      3. A sound macroeconomic framework
      4. Low foreign currency debt

    Moody’s outlook – positive? Like the S&P statement in June, the tone of the Moody’s report was more upbeat than we had expected. It does seem that if the government does enough in the way of structural reform to get private sector investment turning positive in the first half of 2017, then South Africa could avert a downgrade in June as well. And there is a possibility that the rating stabilises next year. However, political infighting remains a challenge. This is the first time since 1994 that private fixed investment has contracted in South Africa in the absence of a global crisis, which highlights this problem.

     

    S&P on Eskom:

    1. S&P unexpectedly downgraded Eskom’s long-term corporate rating to BB from BB+, and retained the negative outlook. Their main points of concern are:
      1. The level of likely government support given the uncertainty around tariff determination
      2. The uncertainty around the renewal of Eskom’s R350bn existing government guarantee, which expires in March 2017. The renewal has no impact on the guarantee of the R170bn of debt that has been issued under this guarantee. However, Eskom will not be able to issue any further guaranteed debt unless the guarantee is extended.
      As Eskom received the first of the guarantees National Treasury issued post the global financial crisis, they contained limited conditions. In contrast, the guarantees issued to other state entities require them to get approval from Treasury for all significant transactions or commitments. We expect that as part of the renewal process of the guarantees, Treasury will look to add a provision that all significant transactions would require approval. This would limit Eskom’s ability to procure nuclear power without ensuring that all due processes are completed. Therefore, S&P’s downgrade of Eskom may actually be long-term credit positive for the SA sovereign credit rating.

     

    SA ratings Foreign LT debt Local LT debt Outlook
    S&P BBB- BBB+ Negative
    Moody’s Baa2 Baa2 Negative
    Fitch BBB- BBB- Negative
    R&I BBB+ A- Negative
    Dagong Global BBB+ A- Negative

     

    Source: Investec Asset Management and Bloomberg, 25.11.16

     

    What next?

    The attention is now focused on S&P which will be making its ratings announcement on Friday evening. While there is much focus on the foreign currency rating, it is a downgrade in the local currency ratings below investment grade that would force outflows of funds that track the Citibank World Investment Grade Bond Index (WIGBI). Therefore we will be closely watching the progress of both when S&P releases its ratings update. S&P currently has a two notch differential between the hard currency and local currency ratings.




    Important information

    All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. We endeavour to provide accurate and timely information but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management is an authorised Financial Services Provider. Issued by Investec Asset Management, December 2016.

  • Fixed Income

    Fixed Income

    Comments on ratings announcements, 5 December 2016

     

    South Africa has some breathing room until June 2017 to show some meaningful improvement in order to move back to a stable outlook. The local currency debt downgrade, however, could lead to some investor concern that if nothing is done to stimulate growth, we could well see another downgrade in six months’ time. This would mean that most of South Africa’s debt would only just fall into the investment-grade category.  We believe our cautious positioning was thus justified. The markets have had a muted initial reaction as global factors are weighing on sentiment at present. We will remain cautious as we digest the result to the Italian referendum and the upcoming Fed meeting. Emerging markets are likely to take their lead from these global events.

     


    Important information

    All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. We endeavour to provide accurate and timely information but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is not a recommendation to buy, hold or sell any particular security. Past performance of investments is not necessarily a guide to future performance. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management is an authorised Financial Services Provider. Issued by Investec Asset Management, December 2016.

  • Emerging Market Debt

    Emerging Market Debt

    Comments on ratings announcements, 5 December 2016

     

    The market will be relieved that S&P has given South Africa some reprieve by not downgrading the country’s foreign currency credit rating. In fact, for once, South Africa seems to be in a relatively strong position compared to some of its peers. Turkey, Mexico and Malaysia in particular are showing some vulnerability since the US election. The rand and South African bonds have outperformed all of these markets. However, local and foreign investors should probably be more concerned about South Africa’s local currency rating which S&P downgraded on 2 December 2016 to BBB from BBB+. Since S&P left South Africa’s credit outlook on negative, 2017 is bound to be another year of worry. Unless there is a further marked improvement in the growth and political outlook, S&P could still downgrade South Africa’s foreign currency rating to junk, which could drag the local rating to BBB-, or one notch above junk. Given that most of South Africa’s bond issuance is in local currency, as opposed to foreign currency, and that many foreign investors hold South African debt because of its investment-grade status, it is important that this rating is maintained.

     


    Important information

    All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. We endeavour to provide accurate and timely information but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is not a recommendation to buy, hold or sell any particular security. Past performance of investments is not necessarily a guide to future performance. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management is an authorised Financial Services Provider. Issued by Investec Asset Management, December 2016.

  • Quality

    Quality

    Comments on ratings announcements, 5 December 2016

     

    International credit rating firms (Fitch, Moody’s and S&P) have kept South Africa’s sovereign rating (hard currency debt) unchanged, with a negative outlook. Our local strategies are likely to benefit from this news given our large bond and select ‘SA Inc’ interest-rate sensitive exposures. However, we caution against positioning for any particular market event. We have been saying over the past year that the environment is becoming far more volatile, with an increasing occurrence of unforecastable event risks pervading markets. We continue to construct sufficient diversifiers, aiming to compound long-term shareholder wealth from here, regardless of market uncertainty and movements. As a result, we did not make any material changes in the lead-up to the ratings announcements given our long-term bottom-up focus. We do not expect to make any material changes now that the result is known.

    While South Africa avoided an S&P foreign currency credit rating downgrade on 2 December 2016, we are definitely not out of the woods yet. There is a lot of work that needs to be done, especially relating to structural reform, to boost investor confidence. A negative outlook means that we are likely to remain on watch for the duration of 2017. This will continue to unnerve markets, leading to ongoing uncertainty and volatility. We believe the defensive growth characteristics and resilience of the companies in which we invest, together with a balance of exposures that have sufficient levers and shock absorbers, should generate consistent returns and position investors relatively well through these volatile market conditions. As always, we remain unwavering in our commitment to growing investors’ capital in a prudent manner.

     


    Important information

    All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. We endeavour to provide accurate and timely information but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is not a recommendation to buy, hold or sell any particular security. Past performance of investments is not necessarily a guide to future performance. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management is an authorised Financial Services Provider. Issued by Investec Asset Management, December 2016.

  • SA Equity & Multi-Asset

    SA Equity & Multi-Asset

    Comments on ratings announcements, 5 December 2016

     

    Investec Institutional Balanced

    We view the announcements of international credit rating agencies Fitch, Moody’s and the most recent statement from S&P relating to South Africa’s credit rating, as positive for the country. While there is still some work to be done to fully restore global investor confidence, for now, the rating agencies have given us the benefit of the doubt. All three agencies have echoed the same broad concerns which relate to political uncertainty, the ability of government policies to lift the country’s structural growth rates and to enhance private fixed investment as well as government making good on promises of fiscal consolidation.

    The primary take-out in our view is that it is unlikely that South Africa will be forced to exit from global bond indices in the coming years. At least two rating agencies must downgrade South Africa to sub-investment grade before the country loses its right of inclusion in global government bond indices. While we believe the recent announcements from international credit rating agencies should provide some support to domestic asset classes and even the rand in the near term, we are not making any material changes at this point in time as there are still a number of significant event risks on the near-term horizon. While risks in the domestic political environment remain elevated, the global environment could dominate sentiment over the coming weeks. The Fed’s interest rate decision and the appointment of Trump’s cabinet, which should provide some indication in terms of the new administration’s policy direction, are some of the key drivers expected to dominate markets in the final weeks of 2016.

    We remain well diversified with a decent allocation to domestic bonds and some exposure to domestic interest-rate sensitive assets which should positively contribute to performance in the near term.

     

    Investec Equity

    The potential downgrade of South Africa’s foreign currency credit rating to sub-investment grade has been the centre of debate, speculation and sentiment for investors for most of 2016. We view the announcements of international credit rating agencies Fitch, Moody’s and the most recent statement from S&P relating to South Africa’s credit rating, as positive for the country. While there is still some work to be done to fully restore global investor confidence, for now, the rating agencies have given us the benefit of the doubt. All three agencies have echoed the same broad concerns which relate to political uncertainty, the ability of government policies to lift the country’s structural growth rates and to enhance private fixed investment as well as government making good on promises of fiscal consolidation.

    While we believe the recent announcements from international credit rating agencies should provide some support to domestic equity market sectors in the near term, we are not making any material changes at this point in time as there are still a number of significant event risks on the near-term horizon. While risks in the domestic political environment remain elevated, the global environment could dominate sentiment over the coming weeks. The Fed’s interest rate decision and the appointment of Trump’s cabinet, which should provide some indication in terms of the new administration’s policy direction, are some of the key drivers expected to dominate markets in the final weeks of 2016.

    Domestic economic-sensitive sectors could find some near-term relief following the credit rating agencies’ announcement, which should benefit shares such as Tiger Brands, Barloworld and broader sectors such as financials and retailers.* While a marginally stronger rand could put some near-term pressure on resources shares such as South32, BHP Billiton and Glencore, these holdings strongly contributed to returns over recent months. They have continued to rerate off exceptionally low valuations and are receiving positive earnings revisions. *

    *This is not a recommendation to buy, hold or sell any particular security.




    Important information

    All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. We endeavour to provide accurate and timely information but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is not a recommendation to buy, hold or sell any particular security. Past performance of investments is not necessarily a guide to future performance. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management is an authorised Financial Services Provider. Issued by Investec Asset Management, December 2016.