SA’s sovereign rating, coupled with a gloomy economic outlook, are indicators of a likely increase in interest rates
The major ratings agencies are widely expected to affirm South Africa’s sovereign rating a notch above junk status with a negative outlook as they release their outlook in the next few weeks. US-based Fitch Ratings was due to be the first to do so on Friday. The poor ratings would be due mainly to tepid economic growth, coupled with large budget and current account deficits that have increasingly held South Africa at the mercy of foreign investors.
Treasury estimates that the budget deficit as a percentage of GDP will come in at 6.1% this fiscal year. This will fall to 4.2% in 2016/17, then narrow to 3.9% in 2017/18.
Government finances the deficit through selling government bonds – and foreign investors’ participation in this market is at historically high levels.
According to Treasury’s latest debt management report, by March last year foreign investors held 37.2% of local government bonds, up from just 12.8% in 2008 and higher than the 29% held by local pension funds.
The current account deficit – a measure of the country’s trade competitiveness – which widened to 6% of GDP compared with 4% six years ago, has settled at 5.1% in the final quarter of last year.
It has primarily relied on financial and capital flows – mainly from foreign investors recently – for financing.
Foreign investors were lured to emerging markets like South Africa after economic stimulus packages, known as quantitative easing – which included low interest rates – introduced by the US and the UK injected money into the global financial system and investors were driven to search for higher yields in riskier markets.
But this is set to change as the Federal Reserve, which ended its quantitative easing programme in October, prepares to raise interest rates later this year. Minutes of the Federal Open Market Committee’s April meeting, released last month, showed that members believed the process of raising rates would run smoothly once it started.
A survey of market participants indicated that the respondents saw the Fed’s September meeting as the date when it would be most likely to raise rates.
On Thursday, International Monetary Fund (IMF) head Christine Lagarde called on the Fed to delay raising rates to the first half of next year as signs of wage or price inflation were not strong enough to raise them earlier.
“The IMF’s call for the Fed to delay hiking rates into next year has not seemingly had much impact on market pricing, the betting is still for September or more probably December,” said Rand Merchant Bank’s John Cairns.
This is already showing on the markets – trade in South Africa’s benchmark 10-year bond registered a fall in value in the past three months, while comparable bonds in the US and Germany gained (
Fears that Greece would default on a €300 million (R4.2 billion) debt payment due to the IMF on Friday, which were averted in a last-minute Thursday deal to bundle it with three other payments payable at the end of June, dragged down all three bonds. “This is allowed under IMF rules, but the risk is that by missing [Friday’s] payment, depositor and investor panic spreads,” said Cairns.
The JSE’s All Share Index has been more resilient, more or less tracking – even overtaking – the MSCI World Index of large and mid-sized companies in 23 developed countries. But it has recorded a cumulative fall since the release of the Fed’s statement.
Overall net inflows from foreign investors, which stood at R25 billion in 2013, halved by the time Reserve Bank governor Lesetja Kganyago announced the monetary policy committee’s decision to keep interest rates unchanged last month.
He said it was not clear how much the Fed’s plans had been priced into the rand and this might push inflation upwards.
He also expressed concern about aboveinflation wage and salary growth, as well as Eskom’s application to Nersa to reopen its tariff determination for this year, which will be decided at the end of this month.
All these factors were an indication of bad news for the Reserve Bank’s inflation outlook and suggested interest rates may rise.