SA’s second downgrade for 2020 leaves markets cold

By Mokgatla Madisha, head of Fixed Interest at Sanlam Investments

Already in 2017 Standard & Poor’s (S&P) and Fitch downgraded our government’s foreign and local (rand) debt rating to non-investment grade. Then on 27 March 2020 Moody’s too announced that it now rates SA local currency debt as non-investment grade, leading to South Africa being excluded from the World Government Bond Index (WGBI).

On Saturday Fitch and Moody’s adjusted their ratings for the SA government, moving it one notch deeper into ‘junk’ status. Fitch downgraded South Africa’s long-term foreign and local currency debt ratings to “BB-” from “BB”. Moody’s downgraded our long-term foreign and local currency debt ratings to “Ba2” from “Ba1”. Both agencies maintain a negative outlook.

This downgrade has no impact on SA’s inclusion in indices

Fortunately, this time round the downgrades do not trigger more exclusions from global bond indices. Fixed income mandates can be broadly classified as either investment grade or sub-investment grade. Previous rating actions carried a lot more significance because the country’s credit rating was straddling investment Grade and sub-investment grade ratings. The risk at the time was that a negative rating action would result in the forced liquidation of positions. After the downgrade in March by Moody’s to sub-investment grade, investors not mandated to invest in sub-investment grade assets exited SA bonds. By implication, the investors currently in SA bonds are either ratings agnostic or the benchmarks they track allow for low ratings.

The risk of a default by the SA government was already priced into CDS spreads

The cost of insuring against default on South African debt (as indicated by CDS spreads) has been much higher than for similar rated countries, implying that the market was rating South Africa much worse than the official ratings from the rating agencies before Saturday’s downgrade. However, now the CDS spreads are in line with a rating of BB.

The downgrade from Moody’s was not wholly unexpected but we did not expect the negative outlook that accompanied the rating change.

So far there has been little response from the market

The bond market did not react a whole lot on the news. In fact, the benchmark R186 bond yield ended up just 6 basis point higher than Friday afternoon’s close, while the long-dated R2048 yield was just 3 basis points higher. This does not mean ratings don’t matter anymore but rather that a significant risk premium was built into the asset class at the time of the ratings adjustment.

In the longer term, however, a low credit rating results in higher borrowing cost and in times of risk aversion it is the lower rated credits that tend to fare worst.

The Reserve Bank’s MPC is aware of the risks Fitch and Moody’s are citing

At the recent MPC meeting the voting members were split 3:2 against a further cut in repo. The SA Reserve Bank (SARB) has conducted monetary policy in a cautious manner precisely because of the risks to the economy stemming from the country’s fiscal position. There is no doubt that if the risk were lower the SARB would be running much looser policy than it currently is. For now it seems that the repo rate is unlikely to be lowered again.

What will be the impact on bond investors?

As the country’s credit rating deteriorates, it will be harder to finance deficits and bond yields will remain elevated. We do not think National Treasury and government will change course and adopt austerity. Returns from bonds will come from high yields relative to cash with less reliance on capital gains.