SA awaits market verdict on downgrade
Now that Moody’s Investors Service has finally put us out of our collective misery and pulled the trigger, we may be in a position to pronounce on a question that has been occupying minds in financial markets for a while.
So, to what extent was SA’s inevitable credit downgrade to Ba1, down four steps from A3 when Jacob Zuma became president in 2009 — a final testament if ever one was needed of the ANC’s mismanagement during the socalled lost decade — already reflected in the price of SA assets?
As the country’s fiscal situation deteriorated over the past couple of years, there has been no shortage of stories indicating that SA was already trading as if it was junk, and possibly even another step lower.
Long before anybody had ever spoken about the coronavirus, SA already boasted the juiciest yields among investible emerging markets. While it was rated higher than the already junked Brazil, in the three months to the end of February, SA’s 10-year yields were on average 2.2 percentage points higher.
And the Moody’s downgrade has been so long in coming that it wouldn’t be unreasonable to expect that prudent investors would have acted in advance.
While it’s almost a given that there’ll be renewed volatility on Monday, this might not be a true reflection of the longer-term prospects for the rand and local bonds.
Late in 2019, about a month after finance minister Tito Mboweni’s midterm budget policy statement gave a hint of what has since materialised, members of the Reserve Bank’s monetary policy committee, including governor Lesetja Kganyago, held a function with journalists in which they were asked about the likely impact of a downgrade.
Deputy governor Kuben Naidoo answered. Noting different market reactions to the infamous finance ministerial firings by Zuma of Nhlanhla Nene and then Pravin Gordhan, he argued that this would largely be determined by prevailing conditions globally and appetite for emergingmarket assets.
There were two possible scenarios, he said. The downgrade could come at a time of net inflows for emerging markets and might then not have an impact on the rand, or it could materialise when the opposite was happening, in which case the reaction could be “dramatic”.
No prizes for being able to tell which of those has come to pass. Irrespective of what shortterm action we see in the market on Monday, the crucial part of Naidoo’s answer was his observations about the longerterm consequences for investors’ perception and treatment of SA.
“If you take a five-year view, your average borrowing costs are going to go up. On average you are going to get more speculative investors and not long-term investors, and therefore you are going to see more volatility in your markets,” he said, adding that data from private banks indicated that anything between $5bn (R88bn) and $8bn in bonds could be at risk of being sold.
“The impact will be negative ... how soon, how sharp, how long that persists, it’s not possible” to tell, he said.
With the coronavirus outbreak and the prevailing market volatility, we can almost be sure of how soon we’ll see that impact. Peregrine Treasury Solutions says the rand could drop to a record R18/$ on Monday.
There might well be more dislocation in the bond markets, which were already stressed and requiring central bank intervention, and cries for proper quantitative easing (QE) might get louder.
Some may also argue that ratings agencies are not as potent as they used to be and that this is likely to pass unnoticed. That argument gained traction after S&P Global Ratings downgraded the US in 2011. Instead of rising, treasury yields went to record lows. Same in Europe. Yields of even the weakest countries fell to record lows during the sovereign debt crisis, even as the ratings companies were downgrading them.
That argument didn’t stand up much to scrutiny as it ignored little details, such as the dollar’s role as a reserve currency and demand for the perceived safety of US treasuries in the midst of a global financial crisis. The euroarea countries were backed by unprecedented buying by the European Central Bank (ECB), which took about 90% of all bonds issued by governments in that period, close to €2trillion (R39-trillion). That is some firepower.
Those central banks are back doing QE to fight the current crisis. Australia went further and said it would target a particular level for three-year yields, the exact thing our central bank said it wouldn’t do with its own bond purchases, neat stressing solution. that Why it merely’wanted can t our to restore the orderly functioning of markets.
On the face of it, QE seems a Bank do the same and just print unlimited amounts of rand and force yields lower, especially in this depressed environment of no growth and little inflation? But it has proved hard to find examples of emerging markets that have done QE and lived to tell about it, so we are not blessed with case studies — that’s if you exclude Zimbabwe.
In fact, most of what’s been written about as far as emerging markets are concerned has been how QE policies elsewhere have affected their financial markets and economies. Anecdotal evidence would suggest that wide-scale QE is easier to do if you are printing US dollars, yen or euros rather than rand or Argentinian pesos. In this QE farm, some pigs are more equal than others.
It took a long and sustained failure of governance to get us where we are. Getting out is going to be a hard slog. There are no miracle cures.