R100bn expected to flow out of SA

This week could see R100 billion flow out of South Africa because of the “junk” status of the country’s debt.

The rand could well weaken to about R19.50 against the dollar, and further downgrades in the future aren’t out of the question, say analysts.

Credit ratings agency Moody’s Investors Service’s downgrade of the country’s sovereign debt at the end of March finally dumped the nation into full junk status.

This week, S&P Global downgraded our foreign and domestic state debt deeper into junk status and said that, although the country had done well to combat the Covid-19 coronavirus from a medical point of view, it would be difficult to handle the long-term economic fallout of the five-week lockdown.

This was because South Africa was in a weak economic position even before the lockdown, it said.

Government announced a stimulus package of R500 billion to handle the crisis and will have to borrow much of it, including through the issuing of bonds to foreign investors.

Junk status means that South Africa’s government bonds on Thursday dropped out of the FTSE World Government Bond Index (WGBI).

Various institutional investors such as pension funds, exchange-traded funds and funds that follow specific indices are not allowed to invest in bonds that are below investment grade.

To date, it’s been estimated that these investors will therefore have to get rid of between R30 billion and R100 billion in bonds, said George Herman, investment head at Citadel.

Many people think investors started dropping the bonds since the Moody’s announcement on March 27, but, according to Herman, these have really been discretionary investors and hedge funds – money that flows quickly in and out – who got rid of all high-risk assets.

Between April 22 and 24, when the WGBI was rebalanced, foreigners only sold about R12 billion of South African government bonds. Herman expects institutional investors to get rid of their holdings this week, which could lead to as much as R100 billion flooding out of the country and giving the rand a pounding.

He predicts a weakening of the rand to about R19.50 to the dollar. At one point on Wednesday, it was still trading at R18.11.

Herman thinks institutional investors were slow to react because they didn’t know what country’s government bonds would replace South Africa’s. Now that they know it is Israel, they are expected to start selling this week.

Read: Battered by economic storms

Nolan Wapenaar, a fund manager at Anchor Capital, is of the opinion that a good deal of the money has already left the country.

In the six months between the announcement that South African bonds would become part of the WGBI and the bonds finally being taken up, investors increased their exposure to South African government bonds very gradually.

“It’s reasonable to expect that the same has happened and that they have got rid of it over time.”

Mexico looks like the next country that will drop out of the WGBI. Wapenaar is of the opinion that the focus will now shift to Mexico and Israel, and South Africa will be forgotten.

He said S&P’s further downgrade was also expected. The good news is that they changed the outlook of the debt from negative to stable.

This indicates that South Africa has reached the turning point at the bottom of the curve. And Wapenaar expects a further downgrade from Moody’s, but not from Fitch Ratings and S&P. The investment pool gets smaller as your credit rating worsens.

Annabel Bishop, an economist from Investec, said that credit downgrades would generally make it more difficult to do business in South Africa: the cost of debt rises, markets are more turbulent and this makes the country more susceptible to further downgrades.

S&P said the Covid-19 crisis had curtailed South Africa’s growth prospects as a result of the long lockdown, poorer than expected external demand and strict credit requirements.

It also expects the economy to contract by 4.5% and the budget deficit to rise to 13.3% of GDP. State debt could be as high as 75% of GDP by the end of the year, and reach 84.7% by 2023, which raises questions about the sustainability of these debt levels.

By 2023, interest rates could make up 6.5% of GDP (or 22% of total government revenue), as opposed to 4.1% of GDP (14% of total revenue) last year.

Bishop writes in a note that interest repayments on South Africa’s higher debt occasioned by increased expenses brought about by Covid-19 would have been easy to afford if South Africa had not been dumped into junk status due to years of excessive expenditure, accompanied by state capture, corruption, and fruitless and wasteful expenditure.

Bishop believes it will take a long time for South Africa to regain investment status.

“Quick, sustained economic growth of more than 3%, and closer to 5%, is necessary to get there eventually.”

Peter Attard Montalto from Intellidex said an emergency budget that shows how the R500 billion in stimulus measures will be financed should actually see the light earlier than July, but this was an indication of how difficult reallocating R130 billion from the current budget would be.

According to Montalto, the Land and Agricultural Development Bank of SA, which this week indicated that it could not meet its debt obligations, will receive a R1 billion lifeline from the state this year.

Although it is uncertain what will happen to other state-owned enterprises (SOEs) like SAA, he welcomed the minister of finance’s general statement that dysfunctional SOEs would be sold.

Intellidex also estimates that state revenue collection could decline by as much as 11% this year.

Edward Kieswetter, commissioner of the SA Revenue Service (Sars), this week told Netwerk24 that Sars had already lost more than R1.5 billion in revenue because of the ban on the sale of tobacco and alcohol.

Wapenaar added that it was now a priority to drive economic growth and create jobs by implementing the correct policies.

Poor revenue collection is a major economic threat because it will leave the state with even less fiscal room. With state debt rising to close to 80% of GDP, this does not bode well for the future.

History shows that problems in developing countries become too big once debt rises to close to 100% of GDP.

“Where we previously had 10 years to improve the fiscal position, we now have half of that.

"If we can’t turn our debt situation around, then there are only unhappy options left over: you print money, or you accept aid from the International Monetary Fund or from China, which comes with a lot of conditions.”

S&P did, however, change the outlook from negative to stable, thanks to a credible and consistent Reserve Bank, a currency that is actively traded, and deep capital markets that will help bring about gradual external and fiscal adjustments.

It said the credit rating could improve if government’s reforms succeed in turning around the upward trajectory of state debt as a percentage of GDP, and if employment and productivity improved substantially and lead to higher per capita GDP growth in real terms.

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