News & analysis

March has not bought an easy end to the quarter for the South African economy, as the nation has been dealing with a mix of structural domestic concerns over the economy and international fears over the spread of coronavirus.

Even before the virus spread globally, the country was struggled with various macro issues – since the end of 2019, unemployment has hit an 11-year high, manufacturing and production numbers have slumped to a 5-year low, and Eskom has experienced its worst ever generation crisis, leaving the entire economy without power for hours at a time. Long-standing structural labour market rigidities and persistent weak business and investor confidence finally made South Africa enter its second recession in two years.

On Friday night last week, Moody’s Investment Services announced that South Africa had lost its investment-grade credit rating after more than 25 years, meaning the country now has a junk rating from all three major international rating agencies.

The announcement was made after the nation went on a three-week lockdown, on the same day as the number of infections passed 1,100 and the first victim died. Moodys’ statement describes the key driver behind the rating downgrade from Ba1 to Baa3 as “the continuing deterioration in fiscal strength and structurally very weak growth”, and does not expect current policy settings to address the concerns effectively. The rating agency has downgraded SA’s long-term foreign-currency and local-currency issuer ratings and senior unsecured debt ratings, as well as the foreign-currency senior unsecured MTN and senior unsecured Shelf ratings to (P)Ba1 from (P)Baa3, as well as its foreign-currency other short-term rating to (P)NP from (P)P-3. Due to the downgrade, South African government bonds will be excluded from the FTSE World Government Bond Indexes, which are tracked by $3 trn of funds. The index will be reweighted in April, with South Africa’s 0.45% weighting deducted from the index.

The announcement was not entirely unexpected. Moody’s downgraded their outlook on South African debt to negative in November, warning of SA’s growing debt-to-GDP ratio, but the icing on the cake was when the country had no choice than to impose containment measures to curb the further spread of the coronavirus. South Africa’s National Treasury sees the downgrade of the country’s debt to junk by Moody’s investors Service as an opportunity to fix the economy and stated that they “take this downgrade as an opportunity to do the right thing”, and acknowledges that instead of putting more money into the economy, the nation should shift to structural reforms.

South Africa’s rand weakened to a record low this morning and breached 18 rand per dollar for the first time in history. An index of SA bank stocks slumped 6.1% on top of Friday’s 12% drop.

Acknowledging the still early stage of the spread and the economic damage that it has already done, this may signal that SA’s economy may get impacted more severely as the virus hits its peak. While further short term downward risks certainly play a role for the rand given the economic outlook and downgraded rating, this does not directly have to translate into an even weaker rand in the long term. The shape that the structural reforms will take will be key in determining a longer term economic outlook. Finance Minister Tito Mboweni stated that the nation will approach the IMF and World Bank for assistance in mitigating the economic turmoil caused by the coronavirus.

 

The South African rand weakening past 18/$ for the first time ever recorded

 

USDZAR – 1 month window

 

MSCI Index 

 

Eskom 2028 bond yield curve – now vs 1 month ago

Author: Ima Sammani, Junior FX Market Analyst.

 

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