Institutional investors and money managers who worked to take advantage of opportunities in emerging markets debt could become forced sellers of South African bonds, as the reality of the country's downgrade by credit rating agencies sets in.
Ratings agencies Standard & Poor's and Fitch Ratings in early April downgraded the country's foreign currency debt to BB+, below investment grade, from investment grade, just days after South African President Jacob Zuma sacked Finance Minister Pravin Gordhan, along with eight other members of the Cabinet.
The downgrade is not just a problem for the country and its ratings: some pension funds might be forced to exit any exposure to the country, as their investment principles and guidelines might prohibit owning debt with below-investment-grade ratings. The downgrade also means investors with exposure to emerging market debt, particularly via indexes such as Citi's World Government Bond index, are facing the prospect of losses due to the heavy weighting of South African bonds, according to sources. As of March 31, the weighting of South Africa in the WGBI was 0.43%.
“We think there could be about $2 billion forced selling on the hard currency side for (South Africa sovereign bonds) post the downgrade. The long end part of the sovereign curve was quite popular with Asia (life insurers), which are quite ratings-sensitive, thus the selling pressure could be more concentrated on that side,” said Ray Jian, portfolio manager, emerging markets sovereign bond at Pioneer Investments in London.
Jan Dehn, head of research at Ashmore Group in London, reiterated the impact of heavy losses. “An investor reacting to the downgrade now (has) probably (lost) 11% on the currency (moves) since March,” he said.
Active and specialist emerging markets managers, however, will have fared better, Mr. Dehn said. “(They) were probably underweight South Africa already in the period leading up to the downgrade as the response from rating agencies was delayed.”
As much as 36% of South Africa's local currency debt, $1.7 trillion, is estimated to be in the hands of foreign investors. Sources warned that should Moody's Investors Service follow the lead of S&P and Fitch, outflows could begin to hit the country at a serious pace. Moody's put South Africa on review for downgrade on April 3. A decision is expected in the next 30 to 90 days, the rating agency said.