S Africa credit downgrade may do less damage than feared

LONDON: South Africa will learn soon whether Cyril Ramaphosa´s first month as president has saved the country's last remaining investment grade rating, but even if it hasn´t, a broader rise in optimism should limit the damage.

Moody´s, with a downgrade review on South Africa since last November, is to make a decision by March 23. A cut to junk - following downgrades by S&P and Fitch - will see the country ejected from Citi´s influential World Government Bond Index (WGBI), triggering up to 100 billion rand ($8.5 billion) in selling by foreign investors.

It is a prospect that sends a chill down the spine of the country´s officials, who know the odds aren´t in their favour.

"It is very difficult to read the body language of the rating agencies," new Finance Minister Nhlanhla Nene said in London this week, having just meet with Moody´s. "If there was a downgrade that would have a negative effect".

Moody´s rarely spares those it puts on a downgrade warning. Only seven of the dozens of countries it has had on review over the last two years have been reprieved its data shows.

South Africa was one of those. None have been saved twice. As a result, markets seem to be going with the form book.

Zsolt Papp, an emerging market debt portfolio manager at JPMorgan Asset Management points to the ´spread´, or premium, investors demand to buy South African government bonds rather than U.S. ones.

That spread is now 245 basis points, which is right in line with the average for ´BB´ bracket ´junk´-rated countries like Macedonia and Guatemala or heavyweights like Turkey and Brazil. "The market is already pricing South Africa as a BB credit," Papp said, although he said he was not sure which way the decision will go.

For a government, losing ´investment grade´ status causes pain because it means certain types of investors -- usually big pension funds or Exchange Traded Funds -- are mandated only to buy high-grade debt.

They are forced to sell any bonds which are downgraded to junk. A 2016 World Bank study, which was co-authored by South Africa´s own central bank, found that being cut to ´junk´ by at least two of the major ratings agencies increases a country´s treasury bill rate by almost 200 basis points on average.