IT’S NOT ROCK BOT­TOM

SA still has a lit­tle way to go be­fore we hit ‘real’ junk sta­tus

CityPress - - Business - DE­WALD VAN RENSBURG de­wald.vrens­burg@city­press.co.za

Most of the ter­ri­fy­ing pre­dic­tions about what “junk” sta­tus will do to the econ­omy are based on “real” junk sta­tus, which South Africa is not yet con­signed to. De­spite that, the ef­fect of the Cabi­net reshuf­fle on South African gov­ern­ment debt is al­ready be­ing felt.

Most of the dam­age was done by the reshuf­fle be­fore ei­ther Fitch or S&P Global’s down­grades this week, with junk sta­tus al­ready “priced into” the rand and the yields on gov­ern­ment bonds.

S&P did not blame the down­grade only on the Cabi­net reshuf­fle, but also cited the state’s con­tin­gent li­a­bil­i­ties, par­tic­u­larly its guar­an­tees to Eskom – a theme picked up by Fitch.

Gov­ern­ment 10-year bond yields weak­ened from 8.3% to 8.84% be­fore ei­ther down­grade.

Trea­sury’s hand­ful of bond auc­tions since the reshuf­fle al­ready re­flect in­vestors de­mand­ing higher in­ter­est rates, which could quickly trans­late into bil­lions in ad­di­tional debt ser­vice costs.

The ques­tion now be­comes whether South Africa will see more down­grades – and how much of that has al­ready been “priced in”.

It is widely ac­cepted that credit rat­ings sel­dom tell in­vestors things they don’t al­ready know, said com­men­ta­tors this week.

The muted mar­ket re­ac­tion to Fitch’s down­grade an­nounce­ment on Fri­day un­der­scores this.

South Africa’s gov­ern­ment bonds were al­ready trad­ing at yields com­pa­ra­ble to those of gov­ern­ments that do have junk sta­tus, and they have been for more than a year al­ready.

John Ash­bourne, an econ­o­mist with Cap­i­tal Eco­nom­ics in Lon­don, pre­dicts that a down­grade by it­self will not lead to a huge in­crease in debt costs.

Even in the case of Brazil, which he said South Africa was “un­fairly” com­pared with, mar­kets ad­justed be­fore the coun­try got junk sta­tus last year.

Adrian Sav­ille, chief strate­gist at Ci­tadel Wealth Man­age­ment, said South Africa’s gov­ern­ment debt had ob­jec­tively been at sub-in­vest­ment grade for a year or more.

“If you put all the non­sub­jec­tive data into a model – things such as gov­ern­ment’s debt lev­els, the cur­rent ac­count deficit and the growth rate – it would sug­gest we are sub-in­vest­ment grade,” he said.

“If you look at the 10-year spreads, I’ll be as bold as to say it is al­ready in the price,” he said of the yields on South African bonds. “We are priced where we should be, so if there is a mar­ket re­ac­tion [to a down­grade], it would be mov­ing away from [an ob­jec­tive price].”

JUNK AND ‘REAL’ JUNK

The S&P down­grade left South Africa’s im­por­tant rand­de­nom­i­nated debt one level above junk, for­mally known as spec­u­la­tive or “non­in­vest­ment grade”.

The debt that got junk sta­tus is the 11% of na­tional debt de­nom­i­nated in for­eign cur­ren­cies. Fitch, how­ever, rated all gov­ern­ment debt as junk. The other ma­jor rat­ings agency, Moody’s, is ex­pected to down­grade South Africa soon, but it may still keep the coun­try one level above junk.

Chris Gil­mour, in­vest­ment man­ager at Bar­clays, said: “Gen­er­ally, you are con­sid­ered real junk if two of the three agen­cies rate you as spec­u­la­tive.”

If South Africa’s lo­cal cur­rency debt be­comes real junk, one con­se­quence could be ex­clu­sion from in­ter­na­tional bond in­dices such as the Citi World Gov­ern­ment Bond In­dex.

Be­ing in it cre­ates au­to­matic de­mand for South African bonds. Fall­ing out would in­stantly lead to sell-offs. This would, how­ever, re­quire both Moody’s and S&P rat­ing lo­cal cur­rency debt junk, which nei­ther have yet done.

SO WHAT IS THE DAM­AGE?

If fur­ther down­grades to lo­cal cur­rency debt are pre­vented, the dam­age could still be lim­ited to what has al­ready been seen this week.

The real eco­nomic ef­fect of down­grades de­pends on a chain re­ac­tion that starts in the cap­i­tal mar­kets, specif­i­cally gov­ern­ment bonds.

Less de­mand for rand-de­nom­i­nated as­sets such as bonds means a weaker rand, which means higher in­fla­tion be­cause South Africa im­ports most of its oil and many other things.

When in­fla­tion rises, the SA Re­serve Bank has to raise the repo rate to try to con­tain in­fla­tion un­der the tar­get of 6%. A higher repo rate then leads to higher in­ter­est on con­sumer credit.

The ul­ti­mate hy­po­thet­i­cal ef­fect of a down­grade is then a com­bi­na­tion of higher in­ter­est on gov­ern­ment debt, which hurts the budget; higher in­fla­tion, which hurts con­sumers; and, ul­ti­mately, higher in­ter­est rates for ev­ery­one with debt.

Absa this week cir­cu­lated a hy­po­thet­i­cal sce­nario where a down­grade makes con­sumer credit costs rise by three per­cent­age points, turn­ing the 10.5% in­ter­est on a hy­po­thet­i­cal mort­gage into 13.5% in­ter­est – a po­ten­tially ter­ri­fy­ing blow to mid­dle class in­comes.

“The SA Re­serve Bank may not do it [raise the repo rate] if the rand re­mains sta­ble to the ex­tent that it has, but I think an­other 5% move to about R15 per dol­lar will force it to raise rates,” said Sav­ille.

Gil­mour said: “The 3% [in­crease in in­ter­est] only re­ally comes into play with fur­ther down­grades, es­pe­cially at a lo­cal cur­rency level. The cur­rent ner­vous po­lit­i­cal sit­u­a­tion gives am­ple scope for such an even­tu­al­ity.

“It is im­per­a­tive that South Africa main­tains its lo­cal cur­rency in­vest­ment-grade rat­ing.”

Gil­mour said that just the S&P down­grade could ne­ces­si­tate a rate in­crease: “It would not sur­prise me to see an in­crease of at least 25 ba­sis points, and more likely 50 with an out­side chance of 100.”

A ba­sis point is equal to one hun­dredth of a per­cent, mean­ing a 50-point in­crease raises the repo rate from 7% to 7.5%.

An­other 5% move to about R15 per dol­lar will force the SA Re­serve Bank to raise rates

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