Moody's downgrades SA and Fitch could follow suit

The cut by Moody's was justified and "we now expect Fitch to downgrade at its next update in December", Peter Attard Montalto, an emerging-markets strategist at Nomura in London,

The cut by Moody's was justified and "we now expect Fitch to downgrade at its next update in December", Peter Attard Montalto, an emerging-markets strategist at Nomura in London,

South Africa’s credit rating may be cut to just above junk by Fitch Ratings next month after Moody’s Investors Service lowered it on Thursday, risking higher borrowing costs, Nomura International said.

Moody’s cited slower growth and rising debt levels as it reduced the nation’s rating one step to Baa2, the second-lowest investment grade. That leaves Moody’s in line with Fitch and one notch above Standard & Poor’s (S&P). Fitch, which reviews the country’s rating in December, has a negative outlook.

South Africa’s economy is set to grow this year at the slowest pace since 2009 amid labour strikes and a power shortage. While the government has shown a commitment to narrowing its fiscal deficit, implementing the budget plan is “challenging,” Fitch said last month.

The cut by Moody’s was justified and “we now expect Fitch to downgrade at its next update in December”, Peter Attard Montalto, an emerging-markets strategist at Nomura in London, said in an emailed note on Thursday. The bank recommends an underweight position in South African bonds.

Brian Bertsch, a spokesperson for New York-based Fitch, declined to comment on his firm’s rating.

South African dollar bonds fell on Thursday, sending yields on notes due January 2024 up three basis points to 4.27%, the highest level on a closing basis since October 13. The rand weakened 1% to 11.2591 per dollar.

Slowing growth
Poor growth prospects will boost the government’s debt burden even after it stepped up efforts to cut spending, Moody’s said. The economy will expand 1.4% this year, the slowest since a recession five years ago, and won’t reach its long-term potential of 3% until 2018, according to Moody’s.

The ratings company raised the outlook to stable, signalling further downgrades are less likely. Moody’s is confident in the government’s ability to reduce spending, Kristin Lindow, senior vice-president at the New York-based firm, said by phone on Thursday.

Policy makers are “committed to narrowing the budget deficit” and “stabilising debt”, the National Treasury said in a statement on Thursday after the announcement by Moody’s.

President Jacob Zuma’s government last month outlined a plan to limit spending growth and raise more taxes, signaling its willingness to sacrifice economic expansion. Public debt will probably rise to 49.8% of gross domestic product by the year ended March 2018, from 45.9% last year, according to forecasts in the medium-term budget released on October 22.

Downgrade risk
While the plan is “supportive of creditworthiness”, the projected increase in debt levels underlines the “pressure on the public finances”, Fitch said in a report on October 28.

“There’s certainly a risk that Fitch downgrades in December,” Nazmeera Moola, an economist and strategist at Investec Asset Management, said by phone from Cape Town on Thursday.

Fitch will probably wait until the government’s budget presentation in February before deciding on any further moves, Barclays said on Thursdau. South Africa can hold onto its investment grade rating for “a while” given that Moody’s and S&P both have stable outlooks, Miyelani Maluleke and Peter Worthington, economists at Barclays’s Johannesburg-based investment banking unit, wrote in a note.

Almost half the time, government bond yields fall when a rating action suggests they should climb, or they increase even as a change signals a decline, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as 38 years. The rates moved in the opposite direction 47% of the time for Moody’s and for S&P. The data measured yields after a month relative to US Treasury debt, the global benchmark.

While the immediate impact from Moody’s rate cut will be limited, “any further shift by any of the agencies would likely start impacting investor behavior more as the sovereign pushes up against the investment grade-junk border,” Nomura’s Montalto said. – Bloomberg

 

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