Recently an article appeared in the Business Day about the Public Investment Corporation (PIC). They believe that a further sovereign downgrade of South Africa by the main credit ring agencies is highly likely due to the low local economic growth coupled with low consumer and business confidence. According to the PIC, in the event of a downgrade, local bond yields will spike to around 1.25% in the short-term and normalize at around 0.65% – 0.85% higher than prior the downgrade event. They also expect a high degree of volatility in the rand.
The headline of this article “Further downgrades highly likely – PIC” as well as headlines such as “South Africa’s Junk Status” have featured prominently in the press. What has not been made clear is that it is our foreign currency (mainly USD) sovereign debt that has been downgraded and not our local/ZAR debt. The former represents 10% of South Africa’s issued debt and therefore has not yet made a meaningful impact on the Rand nor borrowing costs. In fact, the Rand has remained strong on the back of the ‘carry trade’. This simply means that foreign investors are borrowing at low interest rates in foreign markets and investing this capital in markets offering higher interest rates with the rate difference being their return.
The term “junk-status” is constantly front of mind and has now also started to filter through to our big corporates. Just this past Tuesday it was announced that Moody’s downgraded the credit ratings of MTN, Eskom, Sasol and the Airports Company of South Africa, amongst others.
Major global fixed income indices such as the Citi World Government Bond Index (WGBI) and the JP Morgan Global Aggregate Bond Index (GABI) hold the local currency-denominated investment grade debt of countries, including South Africa’s. Large offshore credit and tracker funds are invested so the risk, therefore, lies in South Africa’s local currency denominated debt, which represents 90% of our sovereign debt, being downgraded. This, in turn, would lead to our local debt being excluded from these two major indices as they may only hold investment grade debt.
Should this happen, large offshore credit funds will become forced sellers resulting in a significant increase in both SA’s sovereign borrowing costs and the potential depreciation of the ZAR. To provide some perspective; foreigners hold about 48% of South Africa’s sovereign debt with just these two major indices representing USD17bn (R220bn) or about 18%. Fortunately, South Africa’s ZAR denominated debt is still rated one notch above sub-investment grade by the two major rating agencies; S&P and Moody’s and at sub-investment grade by Fitch with the next scheduled reviews in August and November. We have been actively engaging with various quality fund managers on the issue and will continue to actively monitor the portfolio positioning of our clients given the potential of this downgrade.