M&G fund manager Mike Riddell says South Africa should carry a junk credit rating due to rising financial, political and economic worries, which could have implications for emerging market debt investors.
Last month, South Africa’s sovereign debt rating was cut by Standard & Poor to triple B from triple B plus, just two notches above being rated junk.
Riddell (pictured) says the market and rating agencies continue to underestimate issues regarding South Africa such as debt sustainability, limited fiscal headroom, increased sovereign liabilities and the current account deficit.
The fund manager says South Africa has only just entered the Citi World Government Bond index, which has led to increased inflows, but would drop out if it were to be given a junk rating.
Riddell says interest rate costs would rise “potentially sharply” for sovereigns, banks and corporates, and could lead to a slump in the value of the South African rand.
“If South Africa were to be junked, what would the impact be on emerging market debt more generally? In terms of direct effects, given a 10 per cent index weighting in emerging market local currency debt, a drop of, say, 10 per cent in the rand and 5 per cent in the bonds’ prices would detract 1.5 per cent,” says the manager.
“South Africa has a smaller weighting in external sovereign and corporate debt indices – typically 2-4 per cent depending on the index – so the impact would be less.”
He adds: “Indirect effects are impossible to quantify; at the very least other African countries would likely be hit – many of whom run even larger current account deficits – although these countries form only a small part of the emerging market debt indices. It’s possible that investors will reawaken to idiosyncratic emerging market risks and contagion could spread to other regions.”
Riddell adds: “It’s important not to over-blow the systemic risks, and bear in mind that events in the eurozone, the US and China will obviously be far bigger drivers of returns for the wider emerging market debt market than events in South Africa. Nevertheless the message remains – emerging market debt, not so safe.”