Much has been said about South Africa’s investment grade status over the past few months. Now that much of the noise has subsided, we thought it worthwhile to remind ourselves of where we currently are, what the potential dangers are and what we need to do to avoid a ratings downgrade.
We are graded on both a local and foreign currency outlook. With the local currency outlook (shown in orange), we are still a few notches above investment grade, but it is with the foreign currency outlook (shown in blue) that we are currently at risk.
Looking at where our bonds are currently priced, we should yield at around the blue bar (average BBB-) but we are priced at double that (red bar), showing that the market has already priced in a downgrade to BB+ and more.
While undoubtedly serious, a possible downgrade needs to be seen in context. If we are downgraded, international investors may no longer see our bonds as an attractive investment. Some international investors will be forced to sell foreign currency government bonds if their mandates only allow them to hold investment grade. Only our local currency bonds are included in the World Government Bond Index, so these would not fall out of that index.
Government bonds make up around 64% of our bonds market and foreign currency bonds around 9% of those, so there is potential portion of 5.7% of our bond market that could be forced sellers. This would cause some volatility in the bond market as well as the Rand but this is most likely a short term spike, based on the fact that this news is already priced in.
We are also not alone, countries such as Argentina, Portugal, Brazil, Greece, Russia and Turkey are all below investment grade currently. If we do get downgraded, it will also take a lot of hard work to get back to investment grade, as it takes an average of over 6 years to recover to investment grade status (South Korea managed to do it in a mere 14 months).
The upside is that this issue has finally been brought to the forefront and has highlighted what needs to be done. The ratings agencies have hinted that in order to avoid a downgrade we need to keep the budget in check with no new major long term liabilities (such as nuclear power), strongly limit increases to the government wage bill and encourage growth.