BofA Calls ‘Buy’ on South African Dollar Bonds as Peers Dissent

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Bank of America Merrill Lynch is out on a limb with its call to buy South African dollar bonds.

South African Finance Minister Nhlanhla Nene has shown resolve to get his fiscal house in order, averting the threat of a credit downgrade, BofA economist Vadim Khramov said in a note this month recommending an overweight position in the nation’s external debt. Investors including Aberdeen Asset Management Plc, Investec Asset Management Ltd. and Acadian Asset Management LLC. aren’t convinced.

Dollar bonds of Africa’s most-industrialized economy have returned 1.2 percent this year, beating the 1 percent average for emerging-market nations. The premium investors demand to hold South Africa’s foreign-currency debt rather than U.S. Treasuries fell 28 basis points from a 13-month high in March, according to JPMorgan Chase & Co. indexes.

“South Africa remains the most attractive credit” among emerging-market peers in Africa, the Middle East and Europe, Khramov said by phone from London on July 13. “We expect the government’s fiscal stance to improve, and we consider rating downgrades unlikely this year.”

‘Better Places’

Nene has committed to keeping public spending under control, with the budget deficit forecast to drop to 2.5 percent of gross domestic product by the year ending March 2018 from 3.5 percent, even with economic growth stifled by power cuts and a slump in commodity prices. Fitch Ratings and Standard & Poor’s affirmed the investment-level sovereign rating last month, citing fiscal plans, while Moody’s Investors Service has said there is little chance of a downgrade that could prompt some investors to sell the nation’s debt.

While Nene’s fiscal-consolidation goals are clear and positive, “implementation is always key,” especially in a low-growth economy such as South Africa, said Edwin Gutierrez, the London-based head of emerging market sovereign debt at Aberdeen, which is underweight South Africa and favors Russian and Turkish debt.

“There are better places with better risk-return both in the region and outside of the region,” Gutierrez said by phone on July 13. “You do get higher nominal GDP growth in Turkey and Russia, so that’s helped the debt dynamics to improve.”

Yields on South Africa’s $2 billion of 5.875 percent notes due September 2025 have dropped 23 basis points from a five-month high on June 10. The yield was little changed at 4.5 percent by 4:10 p.m. in London on Friday, compared with 4.7 percent for similar-maturity Turkish debt and 5 percent for Russian securities.

Power Cuts

South Africa’s state-owned electricity company, Eskom Holdings SOC Ltd., has imposed rolling power cuts almost every second day this year, hampering mining and manufacturing output at a time when anemic global growth is damping demand for the nation’s exports and the prospect of a Federal Reserve rate increase this year is drawing capital away from developing nations. Economic growth is forecast to quicken in 2015 to 2 percent from last year’s 1.5 percent, which was the slowest pace since the 2009 recession.

“South Africa’s got fundamental weaknesses in the form of deteriorating budget and fiscal conditions, the Eskom problem, deterioration in the current account that has not responded to the currency devaluation, and I would even add broader concerns about deteriorating governance in the country,” Bryan Carter, a portfolio manager at Boston-based Acadian, said by phone. “That combination of factors makes South Africa look worse than the average emerging market.”

The rand has lost 6.1 percent against the dollar this year. It gained 0.5 percent to 12.3317 per dollar by 5:10 p.m. in Johannesburg.

“South Africa may avoid downgrades over the short term but the trajectory is not encouraging,” said Werner Gey van Pittius, the London-Based co-head of emerging-market debt at Investec. “We are underweight across our portfolios in South African dollar debt.”

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