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On Friday evening 24 November, both S&P and Moody’s announced the update to South Africa’s credit rating. S&P downgraded the foreign and local currency rating by one notch to BB and BB+ respectively. Albeit that this is below investment grade, the ratings agency has removed the ‘negative outlook’.
Moody’s did not lower their credit rating of SA, but they did put us on a ‘review for a downgrade’. Hence at this stage, it rates the foreign and local currency debt of South Africa as Baa3, which is one notch above non-investment grade. What does this all mean? Well if things stay as they are and we see no clear signs of policy action to stabilise South Africa’s fiscal situation, Moody’s will downgrade both foreign and local currency ratings to non-investment grade. This can be interpreted that if the political status quo remains, and Dlamini-Zuma wins the ANC election ahead of Ramaphosa in December, they will downgrade South Africa immediately after the ANC conference. If, on the other hand, the outcome from the conference is different which suggests that policy action (across a variety of areas) will occur, they may delay their decision to just after the February budget. Again whether the budget will bring about fiscal sustainability is debatable, but the rating agency could be giving our country the benefit of the doubt, and good intentions in the budget could see us prevent a downgrade.
Our rating is critical as it affects our government’s ability to repay debt both locally and globally, hence the worse our ratings, the more expensive our debt repayments become, channelling a lot more funds into repayments that could have in fact been used to upgrade essential services (hospitals, schools, job creation etc).
WHAT DOES THIS MEAN?
The most significant implication (in the near term) is that a downgrade to non-investment grade means that we will be excluded from global indices (World Global Bond Index is the main one, where SA’s component in the index is currently over R100 billion). These funds would immediately flow out of our bond markets leading to implications for our currency amongst other factors.
The impact on our bond market will be severe. Granate Asset Management, who manage the fixed income exposure on behalf of our clients and are widely considered one of the best bond managers in the country.
Jonathan Myerson (fixed income fund manager of Granate) has the portfolio positioned in such a way that the fund’s interest rate risk is relatively low compared to the All Bond Index. The decision to keep some interest rate risk in the fund is strictly a valuation call. At current yields, South African bonds are offering good longer term value. The fund remains very liquid which will allow the team to take advantage of this undervaluation as we proceed the next few weeks and months towards getting more clarity around our government’s policy outlook.
Managing the income requirements for our client portfolios and ensuring there is sufficient liquidity to provide for drawdowns is an essential part of our portfolio construction. These fixed income funds are central to this part of our investment management process, and in a time of uncertainty around our political leadership and the possible outcomes following a December election, it is comforting to know that our chosen Fund Manager in this space has considered the possible outcomes, and is positioning these funds to provide stable and consistent returns.