South Africa braces for bleak Moody’s review after budget bombshell

South Africa’s government was bracing for an unfavourable review of the country’s final investment grade credit rating on Friday, bringing an exodus of foreign money from an already debt-riddled economy a step closer.

Moody’s pegs South Africa at Baa3, its lowest investment grade rating, with a “stable” outlook.

The rating agency – the last of the big three not to have consigned South Africa’s rating to ‘junk’ status – told the treasury it was looking “very carefully” at the country’s fiscal position before publishing its review, said Finance Minister Tito Mboweni.

Read: If government was a household …

Moody’s looking ‘very carefully’ at fiscal stance – finmin

“At the most I hope they keep the rating where it is… It’s not looking good,” he told parliament.

On Wednesday, Mboweni forecast wider budget deficits and soaring debt. The economy is barely growing and also saddled with chronically high unemployment.

While many analysts believe an immediate downgrade remains unlikely despite that bleak mid-term budget outlook, they said Moody’s looked almost certain to deliver some sort of negative assessment.

It could put South Africa on “outlook negative”, which would provide a window of 12-18 months before a downgrade might be delivered. Alternatively, a move to “credit watch negative” could lead to a ratings decision within three to six months, they said.

“Moody’s has to go to negative now if they want to have a shred of credibility,” said Kevin Daly at Aberdeen Standard Investments in London.

Markets have reacted nervously to the glum projections. The rand weakened more than 0.6% after a 2.5% drop on Wednesday, its largest daily decline in over a year. Local 10-year sovereign debt yields soared as high as 8.615% – levels last seen in May this year – while dollar-denominated sovereign bonds also suffered a selloff.

And there is little respite in sight for the battered currency, which has weakened nearly 5% year-to-date.

“The imminent review of the South African rating entails the risk of the country losing its last remaining investment grade rating and thus the risk of a downward spiral,” said Commerzbank FX & EM analyst Elisabeth Andreae. “In case of a downgrade of the rating outlook further losses (for the rand) are pre-programmed.”

Eviction 

A full downgrade to non-investment grade would see South Africa evicted from the benchmark World Government Bond Index (WGBI) of local currency debt and trigger a sell-off by investors mandated to buy high-grade debt.

Goldman Sachs said in August that a downgrade of the local issuer rating could lead to $5 billion in passive outflows and up to $10 billion in active outflows.

With funds tracking the WGBI having $172 billion under management and South Africa’s weight of 0.44% in the index, the $5 billion outflow could happen in the space of two months, predicted Reezwana Sumad, senior research analyst at Nedbank.

Goldman Sachs said on Thursday that, while there was now “a higher probability (from a low level) of an immediate downgrade,” its main scenario remained a shift of the outlook to “negative”, either on Friday or shortly thereafter.

It also calculated that an index exclusion could lead to an increase of up to 25 basis points (bps) in long-dated bond yields from passive forced-selling and up to 75 bps overall relative to the bank’s baseline scenario of no downgrade.

JPMorgan also forecast a negative outlook, with a base case for a downgrade in the fourth quarter of 2020.

Meanwhile a treasury official said that all three major credit rating agencies had raised concerns.

“The debt, the unsustainable wages, and growth, that’s what they are concerned about,” said Treasury Director General Dondo Mogajane, adding he had spoken to all of them in the wake of the latest projections and was due to meet S&P one-on-one in the week to come.

Fitch warned late on Wednesday that the government’s plan failed to outline a clear path towards its objective of stabilising debt-to-GDP by 2025/2026.

S&P Global’s primary analyst for South Africa, Ravi Bhatia, told Reuters the fiscal deterioration had been “more than expected.”