We are already priced as ‘junk’

A credit rating downgrade by rating agency Moody’s will likely happen early next year. 

Although this will have some bearing on the bond market, government’s efforts to sort out the fiscus, along with the direction of the global economy, will have a bigger sway, said Old Mutual Investment Group at a presentation on ‘2020 and life beyond junk status’ in Johannesburg earlier this week.

The nominal impact of a downgrade can be seen in the bond pricing of Russia and Brazil, which saw their credit ratings downgraded to below investment grade by all three credit rating agencies by the end of February 2016. Despite having a ‘junk’ rating, Russia and Brazil’s bonds are nevertheless trading at lower prices than their South African counterparts.

The 10-year bonds for Russia and Brazil are currently trading respectively at yields of 6.29% and 7.03%, compared to the 9.21% of South Africa’s bonds, in spite of it still having an investment rating.

SA bonds price in further downgrades

Moody’s is the last of the large rating agencies, which include Standard & Poor’s (S&P) and Fitch, to hold out in granting SA an investment-grade rating. This will soon change.

“We are certainly priced for downgrades by Moody’s and probably for a further downgrade by S&P,” says Old Mutual Investment Group portfolio manager John Orford.

Read: This is what awaits South Africa if Moody’s cuts its rating to junk

Old Mutual Investment Group chief economist Johann Els says this means the government’s commitment to bringing down debt, reducing the deficit and cutting spending can go a long way to boosting investor confidence. The state announcing plans to refinance Eskom, for example, would have a bigger effect on confidence than a downgrade would.

Orford says this can be seen in Brazil, for example, implementing reforms late last year, which resulted in its bond yields falling from about 12% to around 7%.

Real 10-year bond yields

Source: Old Mutual

Although the government has made steady progress in sorting itself out since Cyril Ramaphosa took office in December 2017, Els and Orford say it is not moving quick enough. 

In a sense, it even moved backwards. The medium-term budget released by finance minister Tito Mboweni on October 30 did not fill Els with confidence that the state could cut costs and reduce the deficit.  

“They said in June there would be a 5% spending cut. They came in with significantly less than that. They set up the market to expect an improvement,” he said.

Old Mutual Investment Group chief economist Johann Els. Image: Supplied

Or as Orford puts it: “One way to look at it is to break government spending into non-interest spending and interest spending, and government is not doing enough to bring down non-interest spending.”

Els and Orford say that if government was ambitious, it would bring the deficit down to the projected 4.7% from the 5.9% for 2022/2023.

“Limiting growth in the wage bill is probably going to be easier than cutting jobs or freezing wage increases,” says Els. “This could lead to a lower budget deficit fairly quickly. Limiting growth to 4% per annum could mean cumulative savings of R104 billion.”

However, Els does not think the state has the stomach to push through these changes as it means it will have to tackle weakened but still-powerful trade unions.

Though he feels the government can do more, he was surprised by the positive reception a South African delegation got from US investors on a roadshow a few weeks ago. They thought the country was heading in the right direction and were impressed by its commitment to making the right changes.

Positive sentiment in the US is not the only thing going for SA. Els says it’s possible that the South African Reserve Bank will likely cut interest rates early next year.

Even so, Els and Orford say 2020 looks likely to be a difficult year. 

Autumn is still a far way off.