Emerging markets are rebounding from the second-quarter horror show, but for South Africa’s rand October still holds large risks.
Two events, in particular, loom large: Finance Minister Nhlanhla Nene’s medium-term budget policy statement, and a review of the country’s credit ratings by Moody’s Investors Service.
The rand rebounded more than 3% in September after a 9.6% slump in August, the worst for that month on record. It could extend gains as the dollar resumes its long-term decline, according to Neels Heyneke and Mehul Daya, strategists at Johannesburg-based Nedbank.
Much hinges, however, on Nene, who has to reassure both Moody’s and investors that he has a handle on spending and debt.
Last year, a widening fiscal deficit and slower economic growth projections led S&P Global Ratings and Fitch Ratings to strip the country of its investment rating, sending yields skyrocketing and the rand weaker. That won’t be easy, given that the economy is struggling to emerge from a first-half recession.
“October is key,” said Christopher Shiells, a London-based emerging-markets analyst at Informa Global Markets. “We and Moody’s want to see a medium-term budget policy statement that focuses on fiscal consolidation, and stabilising debt levels, given the low growth environment.”
A positive statement from Nene could push the rand to about 13.75 per dollar, from around 14.22 on Friday, he said
Moody’s rates South Africa’s local-currency debt at Baa3, the lowest investment level. The rating company’s stable outlook on the debt means there is little chance of a change in the assessment soon, though it said last month South Africa has to stabilise its debt to prevent a change to negative.
Disappointing Moody’s would prove costly. Foreign investors own almost 40% of South Africa’s R1.97 trn of local-currency bonds. Should the country lose its investment rating, it would be excluded from Citigroup’s World Government Bond Index (WGBI), sparking outflows of about $5bn (about R70bn) as investors who track the gauge are forced to sell, according to Bank of America Merrill Lynch.
“The bar for Moody’s to act remains high but WGBI exclusion is a long-term risk,” Gabriele Foa, a London-based analyst at BofAML, said in a note dated September 26. “Rough math suggests that while it is not an immediate risk, the long-term risks from potential investment grade losses remain elevated.”
Moody’s was scheduled to review South Africa’s credit rating on October 12, but said last month it may delay until after the budget statement on October 24. For now, traders aren’t overly concerned, if options pricing is anything to go by.
The premium of options to sell the currency over those to buy it in the next month, known as the 25 Delta risk reversal, dropped 38 basis points on Friday to 3 percentage points, the lowest in almost two months.