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Ratings downgrade by S&P

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Ratings downgrade by S&P

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Ratings downgrade by S&P

27-11-2017

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Apocalypse narrowly averted by Patrice Rassou, Head of Equities at Sanlam Investment Management

The sword of Damocles hanging over our heads finally fell when S&P downgraded our local sovereign debt one notch to BB on Friday, 24 November, says Patrice Rassou, Head of Equities at Sanlam Investment Management. However the nightmare scenario of a double downgrade was narrowly averted with Moody’s putting us “on watch” – a negative outlook with a Baa3 rating – with a review to be undertaken in three months after the 2018 budget.

For now the “Apocalypse” has been diverted as our sovereign debt remains part of the Citi World Government Bond Index, which has an estimated $10 billion in mandates tracking our bonds via that index. We will, however, fall out of the Barclays Government Bond Index, which could trigger some selling in the tens of billions.

Bond yields are likely to rise further as investment grade investors exit the domestic bond market.  As yields rise, however, junk bond investors are sure to enter the market given the ongoing search for yield globally, says Mokgatla Madisha, Head: Fixed Interest at Sanlam Investment Management.  With the yield on the Albi currently in excess of 10%, an estimated through-the-cycle 4.5% real yield, bonds are attractively priced and from a tactical point of view, investors should overweight bonds following the downgrade.  Bet sizes will however matter given the uncertainty surrounding the ANC’s elective conference, Nersa’s electricity tariff hike for Eskom and the National Budget to be tabled in February 2018.

Our sovereign bonds have already sold off ahead of the downgrade, and were anticipating a double downgrade – reflecting our weak underlying fundamentals as a country. So this may – perversely –  be seen as a positive surprise, continues Rassou. Already we have seen the currency weaken from below R14 to the US dollar by some 30 cents. That being said, the Rand has been quite stable this year and we doubt that this announcement would cause much more of a sell-off.

Indeed, the Johannesburg Stock Exchange (JSE) has not shown a dramatic response to the downgrade. This could be because almost 60% of the income earned by companies listed on the Johannesburg Stock Exchange today is from offshore sources; our stock market has therefore become less reliant on the fate of the local economy. Taking a longer-term perspective, the JSE has generously outperformed inflation over the past decades. Our market has withstood credit downgrades, political and economic isolation, and worse phases of economic turmoil.

The one concern remains whether Treasury has the freedom to put together a fiscal consolidation plan and, already in their response to the downgrade, there is mention of plans afoot to deliver tertiary education to those who can’t afford it – which would mean that on top of measures to find R40 billion in expenditure cuts / tax hikes, a similar amount may have to be found to deliver on this.

Unfortunately, an economic response plan now hinges on who will dictate economic policy post the ANC December conference. Until then it becomes extremely hazardous to guess if the requisite response will be tabled before next year’s budget to satisfy Moody’s.

The unexpected removal of President Mugabe has created a spill-over of optimism that economic mismanagement has dire political consequences. This link between politics and economics is also likely to play out in South Africa.

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