Junk status: not the end of the line

FORCED SALES OF BONDS NOT HAPPENING YET Most of SA government debt – about 95% of it – is pooled in local (rand) debt but fortunately S&P has not downgraded it to junk status. Yet.

There are three rating agencies: Standard and Poor's (S&P): it is the only agency that differentiates its rating: Separate rating for non-rand (foreign) debt: now junk Separate rating for rand (local) debt: downgraded, but still investment grade, with negative outlook. No fixed date for this to be reviewed, but probably within six months. Moody’s: Only gives one rating for foreign and local debt:

Still two notches above junk with review to a downgrade;

Stated that it is going to finalise a decision within the next one to three months;

It would have to downgrade two notches to get to junk status;

This could happen but it is most likely that it will give one notch now and (possibly) only downgrade to junk status later in the year, everything else being equal. Fitch: Only gives one rating for foreign and local debt: Has downgraded to junk. As things stand, only foreign (non-rand) bonds are junk. There are some bonds funds that are forced sellers of non-rand debt, but this is no real selling pressure yet.

A downgrade to “full junk” status is not imminent and most likely not before October or November.

Foreigners own about R700 billion of SA’s local rand debt; about 20% – or R140 billion – thereof is sensitive to junk status, including foreign and local.

The really big bond fund, the Citi World Global Bond Index (WGBI) for local rand debt, needs to be junk status before forced selling starts. The WGBI is a $500-billion fund and SA is about 0.42% in the index.

“Full” junk status will result in SA being dropped from the index, sparking forced sales of R296-billion worth of local bonds if all investors who invest in, or track this fund are forced to sell by their mandate. There will also be investors who may want to buy SA bonds when the forced sellers are selling (there are always buyers at the right price/yield).

Therefore, I am inclined to think that a number of about R100 billion is a more realistic “forced sale” number of all types of bonds.

A junk status is not automatically a death sentence. If adequate steps are taken, investors will quickly forget about junk status and life will carry on.

If this happens, actual upgrades will take time to happen, but the market will ignore this. Plenty of countries have survived junk status. A very powerful argument can be made that junk status was actually a blessing for many of these countries, because it forced change. Junk status can, however, be a death sentence if no action is taken.

Unfortunately for us, the Cabinet reshuffle itself was clearly given by the rating agencies as the reason. We were actually growing. Things were getting better. All else being equal (mainly no collapse in commodity prices) the danger of junk status was most likely behind us up until two weeks ago.