South Africa‘s struggle to safeguard its last investment grade credit rating has failed to convince the most credit-sensitive global investors and many active fund managers have already voted with their feet.
The precarious credit rating of the continent’s most industrialised nation was put back in play once again last month after the government issued a bleak mid-term budget statement that slashed the growth forecast and showed government debt racing to more than 70% of gross domestic product by 2023.
Days after, Moody’s kept South Africa teetering on the brink of junk by confirming its ‘Baa3’ rating – the lowest rung of investment grade – but revising the outlook to “negative”, opening a 12-18 month window in which a downgrade could be delivered. Fitch and S&P Global Ratings already relegated South Africa to “junk” in 2017.
Data shows many funds have not been prepared to wait for the final shoe to drop and have been jettisoning South African debt over the past few years regardless.
“It’s holding on by a whisker (to investment-grade status),” said Salman Ahmed, chief investment strategist at Lombard Odier. “But from a fiscal point of view it’s definitely not investment grade.”
Allocations to South Africa by global fixed income fund managers with an investment grade mandate have tumbled from 13.5% of assets under management five years ago to just 2.3% at the end of September – the latest available data, according to flow tracker EPFR.
The sample, derived by EPFR from mutual fund filings tracking $35 trillion in assets under management, shows that much of the draw down happened in 2015 when many emerging markets came under pressure from a sharp commodity price tumble.
However, the percentage of allocations by active funds nearly halved again in the summer of 2017 after a Fitch downgrade to junk and a negative outlook by Moody’s – which it rescinded months later.
Many expect the latest dire budget prediction could accelerate outflows of foreign money from the $155 billion government bond market.
“It was a slow burn deterioration, and the budget was clearly not great,” said Ray Jian at Amundi. “They are kicking (the can) down the road, but from a market perspective nobody wants to wait until February for the details – it is a case of selling the bonds first and looking at the budget later.”
Finance minister Tito Mboweni will present the full fiscal picture at the budget statement in February.
The situation looked different a decade ago, when Moody’s admitted the country to its coveted club of A rated – or upper investment grade – sovereigns. In 2012, South Africa joined the benchmark local-currency World Government Bond Index (WGBI).
Yet fast forward through years of stalled reform, economic policy missteps and a failure to tackle the burden of loss-making state-owned enterprises – the spectre of losing more money comes at a difficult time.
Nedbank estimates that outflows of foreign money – both active and passive – from South African bond markets totalled $2.1 billion year-to-date.
The move by active investors is seen as a precursor to forced selling that would be triggered by an WGBI eviction in the wake of a Moody’s downgrade. Estimates of forced selling range between $750 million to over $5 billion, according to Nedbank and Goldman Sachs.
Funds tracking the WGBI are estimated to have $172 billion under management while South Africa‘s weighting in the benchmark at just under 0.5% has barely budged over the past five years.
As a result of the problems, South Africa is forced to borrow at one of the highest real rates for any investment grade credit. Its with 10-year bonds yield more than 8% with inflation running at less than half that.
Yet for many, the risk is still too high.
“We are underweight South Africa compared to other emerging markets,” said Georg Schuh, CIO for EMEA at the German asset management firm DWS. “The situation is really quite fragile there.”