HILARY JOFFE: Moody's likely to delay putting final nail in ‘junk’ coffin

24 March 2019 - 00:21

Will Moody's downgrade us on Friday? And if it does, how much will it matter? Most people, in the investment community at least, expect a Moody's downgrade before the end of this year. Bank of America Merrill Lynch found that this was the expectation of almost 60% of the corporations and investors polled at its recent investor conference at Sun City. Chances are that Moody's, which last year put SA back on "stable" outlook amid Ramaphoria, will put us back on "negative" outlook ahead of a downgrade later this year, after the May election or after October's medium-term budget. In theory, the rating agency, which is the only one of the big three that still has SA on investment grade, could go straight to cutting the rating itself, without warning. In practice, a rating agency that has to do this all of a sudden looks like it had its eye off the ball, and Moody's, which in recent years has twice put SA on review for a downgrade but then pulled back, is likely to be extra careful this time. But after all these years in which it has repeatedly given SA the benefit of the doubt, it's hard to see how Moody's can avoid junking us, however encouraging the outcome of the election and the new post-May 9 cabinet might appear. In its last formal review, in October, it warned that SA's ratings would likely be downgraded if "prospects for a growth revival falter" and/or it became clear that the government would not stabilise its debt burden, including through reforms to state-owned enterprises.Even the Treasury's relatively modest growth forecast of 1.5% for this year and 1.7% next year are starting to look wildly optimistic. As the Treasury itself has pointed out in its scenarios, prolonged load-shedding would mean a recession, and it's not clear whether that even factors in stage 4. Economists are starting to revise their forecasts, and Moody's was already lower at 1.3% for this year and 1.5% next year, but this is still high unless the government and Eskom come up with a plan very soon to get the lights back on.Then there's the fiscal challenge: lower growth would mean the deficit and debt projections in February's budget, which looked grim but fairly realistic, would prove too optimistic - even more so if reforms at Eskom failed to materialise and the bailout proved to be inadequate.But how much would a downgrade matter? There was some complacency after Fitch and S&P junked SA's rating without too negative a reaction in the market. Moody's is different because it's the final one, and a downgrade to sub-investment (junk) grade all round means SA will be ejected from Citi's World Government Bond Index (WGBI), in theory prompting capital outflows because international funds that track the index will have to sell their South African holding. In practice, many have already sold in anticipation - Bank of America Merrill Lynch SA's head of strategy John Morris estimates the Moody's downgrade is already priced into SA's 10-year bonds and equities, and that $8bn (about R113bn) of WGBI funds have already exited, leaving only $5bn that will still flow out.For bond market investors, if and when Moody's will move is key and with bond yields rising and the exchange rate sliding lately in response to the loadshedding and the prospect of a downgrade, SA is already paying more for its money than it was before. But even if the Moody's move ends up having a less-dramatic-than-expected impact on the rand exchange rate and the cost of capital, the psychological impact could be profound, as might the damage to confidence and to the economy. Companies that lose their investment-grade status are called "fallen angels" in the rating-agency world. Once one is fallen, how much incentive is there to behave like an angel? The biggest danger of a Moody's downgrade is that it could prove to be just the first of many. ..

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