SA needs four-notch ratings upgrade to qualify for inclusion in key index

South Africa will face an uphill battle for re-inclusion in Citi’s World Government Bond Index (WGBI), should the two remaining ratings agencies cut the local currency rating to junk.

The country’s local debt rating, currently teetering on the edge of sub-investment grade by Standard and Poor’s (S&P) and Moody’s, would require a four-notch upgrade for re-inclusion in the key index, said Gina Schoeman, a South Africa economist at Citi.

The WGBI is widely used as a benchmark by funds, with some only investing in sovereign debt listed in the index. Exiting the index is likely to cost the country between R80 billion to R100 billion in capital outflows.

An exit would be triggered by sub-investment grade ratings by S&P and Moody’s, which against a backdrop of stagnant economic growth and the prospect of further political uncertainty looms large.

The economy has slipped into a recession, for the first time since the global financial crisis, and economists do not expect a significant uptick in growth from the 0.3% recorded in 2016. Now, global bank Citi has revised its growth forecast down from 0.5% to 0.4% for 2017 due to a sharp negative turn in first quarter growth in the tertiary sector, comprising retail and financial services. It also foresees growth of 0.9% in 2018 and 1.3% in 2019.

But, there are downside risks due to the African National Congress (ANC) policy conference in December. “Yes, depending on who is elected will make a huge difference to South Africa’s outlook,” Schoeman said.

“However, the two years leading to the national election is of course going to be a huge distraction to implementing policy reform and better growth internally in South Africa simply because no matter who is elected, the ANC is still going to be very desperate to remain in power. And that can also come with more radical populist policy-making.”

Fears of populist policies, in the wake of a controversial cabinet reshuffle, have spooked financial markets. The announcement of the now suspended revised Mining Charter, which gave resource firms a 12-month timeframe to increase black ownership to a minimum of 30% from 26%, saw mining shares fall to their lowest levels in over a year.

At the same time, Public Protector Busisiwe Mkhwebane’s prescription that the South African Reserve Bank’s (Sarb) mandate be changed to promote economic growth rather than targeting inflation and ensuring currency stability – which markets viewed as an attack on the central bank’s independence – triggered a selloff in the rand, saw foreigners sell R1.3 billion in government bonds and garnered threats of further downgrades by the ratings agencies. She has since backed down from her challenge to the bank’s mandate.

Still, the country’s credibility among investors remains on the line with ratings agencies expected to rigorously track finance minister Malusi Gigaba’s 14-point growth plan, to which he ascribed timelines to key policy interventions.

Provided there are no major shocks, ratings agencies are expected to wait out the ruling party’s December policy conference before announcing significant changes to the country’s ratings, said Schoeman. “There will be less uncertainty about a lot of things in the economy in 2018.”

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