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Last Updated : Nov 27, 2017 02:52 PM IST | Source: Moneycontrol.com

South Africa on verge of being removed from global bond index after S&P downgrade

S&P downgraded South Africa’s long-term foreign currency debt by one notch to ‘BB’ and its local debt by a notch to ‘BB+’, citing a deterioration of the country’s public finances on account of weak GDP growth.

Pranay Lakshminarasimhan

On Friday, Africa’s most industrialised country got a harsh reality check from the financial world. Rating agency S&P Global downgraded South Africa’s local debt to 'junk' grade, reflecting emerging market investors’ view that the once-prized economy is now in the doldrums.

S&P downgraded South Africa’s long-term foreign currency debt by one notch to ‘BB’ and its local debt by a notch to ‘BB+’, citing a deterioration of the country’s public finances on account of weak GDP growth.

The rating agency's decision means that South Africa is on the verge of getting ejected from major global debt indices like the World Government Bond Index and the Barclays Bloomberg index. Had Moody’s joined S&P in downgrading South Africa’s debt on Friday, the exit would already have taken place.

However, that doesn’t mean South Africa is in the clear. Instead of downgrading it outright, Moody’s placed South Africa on review, thereby delaying the imminent rating downgrade. Membership in most major debt indices, particularly the World Government Bond Index, requires a country’s debt to be rated investment grade by either S&P or Moody’s.

Reasons for downgrade

After South African Finance Minister Malusi Gigaba recently revealed the dire state of the country’s public finances, investors around the world grew worried that a downgrade in credit rating was just around the corner.

After it announced the downgrade on Friday, S&P said that South Africa’s economy had stagnated and “external competitiveness” had eroded. “We expect that offsetting fiscal measures will be proposed in the forthcoming 2018 budget in February next year, but these may be insufficient to stabilise public finances in the near term, contrary to our previous expectations,” the rating agency said.

S&P revised its outlook on South Africa to ‘stable’ and said that it expects the country to grow only 0.7 percent this year and 1 percent in 2018. It also pointed out that South Africa had not net created jobs since 2015.

Impact of Moody’s downgrade when it happens

Most experts believed that Moody’s and S&P would downgrade South Africa together on Friday but the former abstained from doing so. If and when the downgrade comes, South Africa will no longer remain a part of numerous global debt indices that are tracked by investors around the globe.

Currently, South Africa’s bond market is one of the deepest and most sophisticated among developing economies, with plenty of foreign investment. However, the rating downgrade will force a lot of foreign investors to pull out of the South African market as they typically require investment-grade ratings.

In addition to this, some investors will exit South African bonds simply because South Africa will not be a part of global bond indexes as they prefer to invest only in index constituents. This exodus will likely burn a USD 10 billion hole in the country’s USD 125 billion bond market.

Possible impact on bond yields

Even before the S&P downgrade, South African government bond yields were trading in the 9 percent band, markedly higher than those of Indonesia, Hungary or Romania, which carried the same credit rating as South Africa.

Even though the market has largely factored in the junk-grade rating, it would not come as a surprise if South African gilts see a further sell-off and yields rise to 9.85 percent or higher if and when the downgrade from Moody’s comes. The South African 10-year government bond yield is currently trading at 9.41 percent.
First Published on Nov 27, 2017 02:50 pm
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