South Africa Junk-Rating Risk Surges on Gordhan Fraud Charge

  • Probability of central bank tightening policy increased
  • Gordhan is scheduled to table mid-term budget on Oct. 26

S. Africa Credit Downgrade If Gordhan Removed: Nomura

Fraud charges against South African Finance Minister Pravin Gordhan have moved the country a step closer to a junk rating and put the possibility of an increase in borrowing costs back on the table, investors said.

Gordhan was summonsed on Tuesday to appear in court on Nov. 2, a month before S&P Global Ratings is due to release the review of its assessment on South Africa’s credit, which is at one level above junk. The cost of insuring against non-payment of debt for five years using credit-default swaps rose to the highest since July after the news, the rand weakened the most since June against the dollar and forward-rate agreements, used to speculate on borrowing costs, surged.

“South Africa is right at the bottom of the investment-grade spectrum,” Simon Quijano-Evans, an emerging-markets strategist at Legal & General Group Plc in London, said by e-mail. “Anything that can lead to a deterioration of the ratings backdrop will scare investors.”

The summons is the latest twist in saga that began in December, when President Jacob Zuma fired then Finance Minister Nhlanhla Nene and replaced him with a little-known lawmaker. Zuma was forced to reconsider when the rand and bonds plunged, and reinstated Gordhan to the position he held from 2009 until 2014. The tussle over control of the National Treasury has dented investors’ trust and business confidence is near a three-decade low while the economy will probably expand at the slowest pace this year since a 2009 recession.

To read more on why the controversy is roiling markets, click here

Policy Uncertainty

S&P and Fitch Ratings Ltd., which will both review their credit assessments in December, kept their ratings at one level above junk in June, and S&P kept the negative outlook, while saying the government must take decisive steps to bolster growth, quell policy uncertainty and end political turmoil. Moody’s Investors Service is scheduled to review its rating, which is at two levels above junk, with a negative outlook, on Nov. 25.

Markets are already pricing in a rating downgrade. CDS prices jumped 17 basis points since Tuesday to 267, higher than those for Turkey and Russia, both rated below investment level by S&P and Moody’s. Yields on benchmark 10-year government bonds surged 24 basis points to 8.94 percent, the highest after Turkey and Brazil among 24 emerging markets tracked by Bloomberg. The rand slumped 0.2 percent to 14.3954 per dollar by 10:26 a.m. in Johannesburg on Wednesday after plunging 3.9 percent on Tuesday.

“Many investors have already discounted some sort of downgrade,” Fabian de Beer, chief investment officer at Mergence Investment Managers Ltd. in Cape Town, said by phone. “We have seen a huge chunk of selling in the last week on the bond side. If foreigners get influenced by what the rating agencies say or the prospects, they will take a bit of a more cautionary view.”

Bond Outflows

Foreign investors have sold a net 6.84 billion rand ($477 million) of South African bonds in the past five days, reversing inflows of 62 billion rand this year to the end of September, according to JSE Ltd. data.

Gordhan led efforts earlier in the year to stave off a downgrade and attended an investor conference with a delegation of business leaders and central bank Governor Lesetja Kganyago in New York last week to boost confidence in the economy. The minister is scheduled to table the mid-term budget policy statement in parliament on Oct. 26.

“Of the three big agencies, the one that will be provoked the most is S&P,” Adrian Saville, chief strategist at Citadel Investment Services, said by phone on Tuesday. “They’ve been perhaps the clearest about concerns around political stability, policy clarity, implementation and so on. S&P is not only the most negative on South Africa, but they’ve also been the most outspoken about the political fabric.”

‘Worst Outcome’

The decision to summons Gordhan is not a huge surprise as S&P expected “at some point he would be called in,” Ravi Bhatia, London-based director at the ratings company, said in an e-mailed response to questions. While this is “a distraction,” S&P is “primarily more focused on South Africa’s economic and fiscal outcomes,” he said.

Moody’s communication desk referred to its September credit opinion, which identified uncertainty about the leadership at the Treasury and political infighting as greatest risks to the nation’s credit rating.

While the Reserve Bank has said it may be near the end of its interest-rate increase cycle, forward-rate agreements starting in nine months, used to speculate on borrowing costs over the period, are now pricing in 29 basis points of policy tightening compared with 6 basis points a week ago.

“This is just about the worst outcome,” Iraj Abedian, chief executive officer at Pan-African Investments and Research Services in Johannesburg, said by phone. “In this type of volatile, highly sensitive and the same time confusing situation, the Reserve Bank remains the remaining anchor of stability and all that means it will resort to potential rate hikes.”

(A previous version of this story corrected the spelling of the former finance minister’s name in fourth paragraph.)

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