Default Risk Above Colombia Flags Downgrade: South Africa Credit
South Africa’s credit rating is headed to the brink of junk within the next year as investors anticipate Standard & Poor’s will follow last week’s downgrade with another cut, trading in default swaps shows.
The cost of protecting the nation’s debt against non- payment for five years has increased 32 basis points to 162 since mining strikes began on Aug. 10, a bigger jump than for any investment-grade country, according to data compiled by Bloomberg. The contracts are trading 53 basis points above Colombia, rated one level below South Africa at BBB-, the last step before junk. S&P, which said the strikes may lead to increased state spending, kept South Africa on negative outlook when lowering its long-term foreign-currency rating to BBB from BBB+ on Oct. 12.
S&P’s move last week suggests government policies that ensue may prompt further downgrades in the first half of 2013, Peter Attard Montalto, a London-based economist at Nomura International Plc, wrote in an e-mailed note on Oct. 12. There is “no sense the government yet has any handle on how to arrest the situation in the short run and prevent contagion,” he said.
Rising social tensions before 2014 elections may prompt the government to boost spending as the economy grows at the slowest pace since the 2009 recession, S&P said in a statement. Labor unrest that began at Lonmin Plc (LMI)’s Marikana platinum mine two months ago spread across Africa’s largest economy, leading to food and fuel shortages in parts of the country and wage increases of as much as 22 percent for some workers.
“They could cut the rating again in 12 to 18 months if things don’t improve,” Colen Garrow, the chief economist at Meganomics, said in a telephone interview from Johannesburg. “Bond investors are not likely to be happy.”
The rand posted the biggest drop among emerging-market currencies after the downgrade, slipping 0.8 percent to 8.7295 per dollar on Oct. 12. The currency has lost 7.6 percent since Aug. 9, the worst performer among 25 developing-nation currencies tracked by Bloomberg. It weakened 0.2 percent to 8.7470 a dollar by 12:45 p.m. in Johannesburg.
The yield on South Africa’s rand-denominated bond due March 2021 rose 3 basis points today to 6.76 percent.
South Africa’s dollar-denominated bonds fell 0.6 percent this month, more than any other country tracked by JPMorgan Chase & Co.’s EMBI Global Index except Gabon and Ghana, trimming their gain this year to about 10 percent. Debt from Colombia, which S&P has on positive outlook, rose 1.8 percent since Sept. 30, extending its advance this year to 13 percent. Emerging- market bonds increased about 1.2 percent this month, and are up 16 percent for the year.
The extra yield investors demand to hold South African dollar bonds rather than U.S. Treasuries reversed an earlier increase to fall four seven basis points today to 181, or 1.81 percentage points. The so-called spread was 72 basis points above Colombia, compared with 39 on Aug. 9.
“The market sees that this is not a hiccup or a temporary shock that will go away if you wait,” Benoit Anne, the head of emerging-markets strategy at Societe Generale SA, said in a telephone interview from London.
About 46 people died in violence that erupted during a six- week stoppage at Lonmin’s Marikana operation. The strikes in the year to mid-September caused 4.5 billion rand ($515 million) in platinum and gold mining production losses as of the middle of September, weakening an economy that is already struggling with the impact of the European debt crisis, President Jacob Zuma said in a speech in Johannesburg on Oct. 11.
S&P said the ruling African National Congress, which has led the country since all-race elections in 1994, may “take on board more populist elements for its policy framework” before the 2014 elections.
“Weaker business and investment confidence may weigh on the economic growth outlook,” the rating company said.
The economy will grow no more than 2.5 percent this year, the slowest pace since the 2009 recession, while the current account deficit will widen to 5.1 percent of gross domestic product, the biggest shortfall since 2008, according to S&P.
South Africa’s Treasury said in an e-mailed statement on Oct. 12 that its fiscal plan “is realistic and achievable.” There’s “no historical evidence” to support S&P’s assessment that social tensions in the country will increase pressure on government spending, the Treasury said.
The timing of the decision was a surprise, Finance Minister Pravin Gordhan said on Johannesburg-based SAfm Radio today. Fitch Ratings plans to give its view on the economy in January, after the ANC’s electoral conference, he said.
Zuma said that union leaders and government officials he met with on Oct. 12 in Pretoria agreed to take steps to improve public and investor confidence in the economy and to promote social stability, according to a statement handed out to reporters. They also welcomed the end of a strike by truck drivers and welcomed efforts to end walkouts in the platinum and gold mining industries, according to the statement. South Africa is the world’s largest producer of platinum.
Zwelinzima Vavi, general secretary of the Congress of South African Trade Unions, told reporters after the meeting that the S&P downgrade “is a huge concern.”
The Reserve Bank will review its forecast of 2.6 percent economic growth this year to reflect the effect of the strikes in the mining and transport sectors and the credit downgrades by Moody’s Investors Service last month and by S&P, Deputy Central Bank Governor Daniel Mminele said yesterday in Tokyo, according to a copy of his speech posted on the central bank’s website.
“The rand appears to have decoupled from the euro movements, taking its cue instead from domestic developments, including the credit-rating downgrades, widespread strike action and the current account deficit,” Mminele said. “Growth forecasts will most likely need to be revisited.”
Last week’s cut comes about two weeks after Moody’s lowered the nation’s debt rating for the first time since apartheid, to Baa1, one level above S&P’s. Moody’s cited the government’s “reduced capacity to handle the current political and economic” challenges for the reduction.
A global hunt for higher yielding emerging-market assets is overriding concerns about South Africa’s political landscape and economic fundamentals, said Alfredo Viegas, managing director for emerging markets at Knight Capital in Greenwich, Connecticut.
“We can opine about fundamentals deteriorating and point to a whole slew of factors from the current account to the rand to reserve levels at the central bank, all of which would give us pause,” Viegas said in a telephone interview. “But until we start to see a significant reversal of fund flows it doesn’t really matter, unfortunately.”
Almost half the time, government bond yields fall when a rating action suggests they should climb, or they increase even as a change signals a decline, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as 38 years. The rates moved in the opposite direction 47 percent of the time for Moody’s and for S&P. The data measured yields after a month relative to U.S. Treasury debt, the global benchmark.
South Africa’s credit default swaps trade on par with Turkey, which is rated BB at S&P, or two steps below investment grade. They are 48 basis points below that of BBB- rated Iceland, the narrowest since 2008 when bank defaults forced the Nordic country to seek an international bailout. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government fails to adhere to its agreements.
“Investors will consider South Africa a riskier place for some short-to-medium term investments,” Mark Rosenberg, an analyst at Eurasia Group, said in an e-mail. “It will be difficult for the government to address these concerns given the political risks, as well as a more negative growth outlook.”
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