SocGen Predicts ‘Volcano Eruption’ for Debt: South Africa CreditRobert Brand
South African bonds face the risk of a selloff by foreign investors as the rand’s plunge dims the allure of the nation’s debt, according to Societe Generale SA.
The rand’s 8.6 percent fall against the dollar this year is the worst of 25 emerging markets monitored by Bloomberg. South African 10-year yields have climbed 14 basis points this month, compared with a 13 basis-point drop for similarly-rated Mexico.
Risks for foreign investors have increased as South Africa posted a current-account deficit close to a four-year high in the fourth quarter after mining strikes and slower growth in Europe cut exports from Africa’s largest economy. A widening shortfall requires more foreign inflows to pay for imports, a source of funds that has dwindled after record 2012 purchases.
“There is trouble brewing in South African markets,” Benoit Anne, the London-based head of emerging-markets strategy at SocGen, said in an e-mailed response to questions yesterday. “We may be getting closer to a real-money investor capitulation, the market equivalent of a volcano eruption.”
SocGen is underweight South African bonds in its Emerging-Market Optimal Local Bond Portfolio. The nation’s debt of all maturities longer than one year has lost 7.2 percent for dollar investors this year, the third-worst after Japan and the U.K. among 26 sovereign markets tracked by the European Federation of Financial Analysts Societies and Bloomberg.
The rand weakened 1.1 percent to 9.2692 per dollar by 6:07 p.m. in Johannesburg. Yields on government bonds due February 2023 rose 2 basis points, or 0.02 percentage point, to 6.86 percent. The yield may rise to 6.97 percent by year-end, according to the median estimate of five analysts in a Bloomberg survey.
The currency’s decline already reflects the deterioration in the nation’s economy and the rand is poised to recover, HSBC Holdings Plc analysts Di Luo, Murat Toprak and Murat Ulgen said in a research note e-mailed to clients today. South African debt will continue to benefit from strong investor flows into emerging markets, they said.
“Currency weakness itself does not lead to bond capitulation,” the HSBC analysts wrote. “An extension of the downward spiral of the rand is unlikely if fixed-income capitulation does not materialize.”
Foreign investors have been net buyers of 13.5 billion rand ($1.5 billion) of South African bonds this year, or an average of 1.2 billion rand a week, compared with average weekly purchases of 1.8 billion in 2012, according to Bloomberg calculations based on data from the Johannesburg Stock Exchange.
The current-account gap reached 6.5 percent of gross domestic product, down from a revised 6.8 percent in the third quarter, which was the biggest shortfall since the same period in 2008, the Reserve Bank said on March 12.
The deficit may narrow as the weaker rand boosts the competitiveness of South African exports, Bruce Donald, a currency strategist at Standard Bank Group Ltd. in Johannesburg, said in a March 18 note. “It is perhaps becoming hazardous to position for further real depreciation of the exchange rate.”
The Reserve Bank will leave its benchmark repo rate unchanged at 5 percent tomorrow, maintaining the rand’s yield advantage over the dollar, according to all 19 economists in a Bloomberg survey. The premium investors receive for holding South African 10-year debt rather than U.S. Treasuries has climbed seven basis points this month to 489.
The risk of forced blackouts by Eskom Holdings SOC Ltd., the state-owned electricity company, may weaken the rand to 9.95 per dollar, Peter Attard Montalto, a London-based emerging-markets economist at Nomura International Inc., said in a note yesterday. The currency also faces threats from labor disputes, a widening budget shortfall and a potential credit-rating downgrade, he said.
The rand fell 15 percent against the dollar in the first quarter of 2008, when coal shortages and maintenance at power plants forced Eskom to cut electricity to the nation’s mines. South Africa’s credit outlook was kept at negative by Standard & Poor’s last week. Fitch Ratings cut the debt rating one level to BBB in January, following downgrades by Moody’s Investors Service and S&P last year.
“General fiscal worries should continue to combine with growth and balance-of-payments worries to be a key and ongoing market driver,” Montalto wrote. “Our view of weakness from here is still intact.”
The cost to protect South African dollar-denominated sovereign debt against non-payment for five years using credit default swaps jumped 27 basis points this year to 170. The swaps, which increase when risk perception deteriorates, pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower breaks debt agreements.
“While the rand has sold off aggressively for a while, so far local rates have generally lagged,” Anne at SocGen said. “Bond selling has been fairly contained. This may change as stress continues to build up in the foreign-exchange market.”