NEDBANK chairman Reuel Khoza has said the government is not taking seriously recent downgrades of South Africa's sovereign rating by two ratings agencies. Failure to reassure investors could lead to further downgrades, giving government bonds junk status, with disastrous results.
Khoza predicted junk status would trigger automatic institutional selling of SA's bonds with a rise in yields, a plunge in the rand, rising inflationary pressure and higher short-term rates.
S&P rates SA at BBB (one grade above junk), Fitch has it at BBB+ (two above junk) and Moody's downgraded the country from A3 to Baa1 (two above junk).
What is junk status and how does it affect the country?
Anything above BBB- is considered investment grade. If a country's bonds fall to that grade or below, large international pension funds are prevented by internal rules from buying them as they are considered too high-risk.
So a country will find it harder to borrow via bonds sales to fund projects like infrastructure development.
Rising yields mean the government of a country with junk status must pay far higher interest rates to buyers of its bonds because of this perceived risk. And rising interest rates would hit South Africans in the pocket.
Erik Nel, fixed-income strategist at Atlantic Asset Management, said rating agencies are getting concerned about policy direction.
Nel felt SA was due for one further downgrade, but more for agencies to align with each other - Fitch is expected to follow suit - and not as a result of multiple downgrades. Still, it would bring SA closer to a "sell button" for foreign holders of its debt assets.
"Multiple downgrades would most likely be a result of a dramatic step to the left by the ANC - something that cannot currently be seen as a base case, given the ANC's own rhetoric."
Independent analyst Ian Cruickshanks said concerns for foreign bond holders would be nationalisation or greater state intervention in the economy. Mangaung and its outcomes would be more important than the pre-conference rhetoric.
Although junk status would indicate SA as a high-risk investment, its ability to repay debt is comparatively strong.
"Our debt-to-GDP ratio still looks pretty good at around 30%, especially when you consider that the US debt ratio is over 90% and Japan's is over 200%. We're relatively underborrowed by comparison.
"Even if we borrow more to fund the government's infrastructure plans, we should still not go much over 40%. By international standards, this is no cause for concern," said Cruickshanks.
Both analysts said SA's recent inclusion in the Citi Bank World Global Bond Index brought with it a rise in bond buying by foreigners, smoothing out the rand's weakening.
"I don't think a downgrade would trigger automatic selling off, because in terms of large institutional funds' holdings SA bonds would make up maybe 1% of their investments.
"My guess is that they would hold onto our bonds because the yields are so good by international standards - around 7% or 8% while many other countries with better sovereign ratings are offering 2% or less.
"However, they would not be allowed to buy any more of our bonds, presenting a hurdle to future offshore funding and putting more strain on domestic resources," Cruickshanks said.
What does this mean for local retail investors, who buy government bonds as part of retirement savings for similarly attractive yields?
"Debt investors should concern themselves with a country's fiscal outlook and general direction of policy. SA's government debt is relatively low, but the trend in the debt ratio is a concern," said Nel.
"Of further concern is the inability of government to arrest the ever-growing public sector wage bill and the ever-expanding social welfare net. SA needs to find a way to correct the ever-widening gap between unit labour costs and productivity growth."
Investors needed to listen to all news from the state.
The ANC elective conference would be the first signpost to gauge whether nationalisation rumours were nothing more than hot air.
"The second signpost will be the state of the nation address, with the final signpost the tabling of the national budget. Within the next three months local interest-rate investors will have enough information to assess whether SA Inc is taking a leap into the unknown [developmental state], or whether it is business as usual, which should arrest the recent slide in sentiment and ensure further portfolio inflows.
"Unfortunately, policy implementation will need to improve materially to ensure that the more coveted foreign direct investment makes its way to our shores."
* This article was first published in Sunday Times: Business Times
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