As if being knocked out of the ICC Champions Trophy by India wasn't enough, Moody’s has downgraded South Africa’s rating by one notch to Baa3 (with a negative outlook); both Standard and Poor’s and Fitch cut the country’s ratings to sub-investment grade, BB+, in April. Moody’s review, which started at the beginning of April, showed that although there are ‘a number of important strengths that continue to support South Africa’s credit worthiness’, a weakening institutional framework, uncertain policy and slow structural reform, and fiscal erosion are hampering growth.
Having been branded the ‘wait-and-see’ economy, South Africa has slipped into a technical recession this year, after two consecutive quarters of contracted growth, due to a sharp contraction in manufacturing and trade. To make matters worse, over a quarter of the population is unemployed; a problem which appears to be getting worse with Q1’17 unemployment recorded at 14-year highs of 27.7%. There are also the obvious concerns over the political climate, made worse by President Zuma’s reshuffle of the cabinet earlier this year, making what some called controversial decisions. Moody’s sees these risks ‘as posing a threat to near-and medium-term real GDP growth.’
The country’s fundamentals have obviously deteriorated, and weakening consumer and business confidence has seen a huge fall in foreign direct investment (FDI), thus a further drag on growth. In fact according to sources, FDI has plummeted over the past decade with South Africa receiving less investment compared with other emerging economies, including ‘poorer’ neighbouring countries. This weakening backdrop is one of the many reasons why we at Stratton Street do not hold any South African debt; despite the country remaining investment grade on a best rating basis and ranked 3 star on our NFA model.
There is also very little value in the country. By way of example, the sovereign’s 6.25% 2041 benchmark bond, rated Baa3/BB+, is currently offering an expected return and yield of just under 11%, with less than one notch of protection. Meanwhile Qatar 6.4% 2042, which is rated 6 credit notches higher, has an expected risk-adjusted return of 11.7% alone, with the addition of a 4.3% yield, and in excess of 4 notches of spread cushion.