by Ashley Horwitz
On Friday night Moody’s downgraded South Africa’s sovereign credit rating to sub-investment grade. Both Fitch and S&P downgraded South Africa to below investment grade in 2017, but Moody’s has always had a soft spot for South Africa.
The key driver behind the rating downgrade to Ba1 is the continuing deterioration in South Africa’s fiscal strength and structurally very weak growth, which Moody’s does not expect current policy settings will address effectively. Furthermore, the outlook for economic growth as well as government finances is far weaker than Moody’s previously assumed. The negative outlook reflects the risk that economic growth will prove even weaker and the debt burden will rise even faster and further than currently expected, weakening the government’s debt affordability and, potentially, its access to funding.
The cut has some significant consequences for the country, its cost of borrowing in the future and investor sentiment towards our equity and bond markets.
One of the biggest consequences is that South Africa’s government bonds will be excluded from the FTSE World Government Bond Index (WGBI), and investment funds tracking the index will have three months to disinvest from their holdings of South African bonds.
Over and above this, Global Institutional active asset managers, whose mandate prohibits them from investing in “junk” bonds, will also be forced to sell down.
Although the immediate impact of both is likely to be fairly limited relative to the recent Covid-19-related bond market weakness, South Africa’s real bond yields remain amongst the highest in the world even if you take into account that the downgrade is more than priced into the yield when compared to other junk status economies. The fact that most of South Africa’s debt is rand-denominated provides further shelter in the face of the battered currency.
Below is a curated consensus of various Asset Managers and their view on the downgrade which constitutes our own house view:
- Sygnia Asset Management believes that the Covid-19 combat measures and simultaneous oil shock following the breakup of OPEC+ have accelerated the pace of global “Japanification” through a global deflationary supply shock, accelerating the move of bond yields in most developed markets towards zero. It is likely that many major developed nations will follow the same trajectory as Japan, where the central bank and government have consistently committed to reducing their budget deficit over the long term, but the budget deficit has instead continued to grow.
As a result, the “search for yield” could continue over the medium to long term, with South Africa being at the top of the list.
Fortunately, the Reserve Bank has allowed South African banks to work together to find solutions for corporates struggling with debt repayments; an advantage of having a concentrated banking system is that coordinated action is possible.
- Stanlib Asset Management believes that assessing the impact of this downgrade on financial markets is difficult under current circumstances.
However, it seems fair to argue that the downgrade has been more than priced into SA’s currency and bond markets.
While the rand and bond market might not weaken substantially further as a result of the downgrade, the move to below investment grade by the one credit rating agency that had for many years expressed confidence in SA’s ability to generate an economic revival will hurt household and business confidence at a time when the country is under enormous pressure.
This is not a time to blame the messenger but rather reflect upon the factors that have brought the country to this point and, more importantly, on the decisions that need to be taken to get SA back to investment grade.
In our opinion, this downgrade has been long in coming and this, together with the Covid-19 pandemic, will ignite the required action by the South African Government to make and take the necessary bold actions that will steer South Africa toward the much needed reforms required to resurrect our economy and move us onto a growth path.
We at Morebo continue to monitor your investments closely and have taken every precaution to ensure that we limit risk where possible.
Please don’t hesitate to contact your Morebo Financial Planner if you require any assistance or advice concerning your financial plan. We may not be in the office, but we are all still working and will be happy to assist you.
In closing, all of us at Morebo wish you and your family well over these trying times and we hope that it will not be too long before we can meet over a cup of coffee.
Our best wishes to you and yours.