South Africa is due ratings reviews this Friday. Chances are that the Standard & Poor’s agency will cut its BBB rating by one, or possibly even two notches. Another agency Fitch has a stable outlook on the rating but could still choose to downgrade the rating rather than the outlook. What will be the damage?
There is undoubtedly a link between ratings and bond prices. So a one-notch ratings downgrade tends to lead to roughly a 20 percent increase in bond yield spreads and credit default swaps (instruments that are used to hedge against default), according to calculations by JPMorgan. But in South Africa the lower credit rating may already be already reflected in asset prices — Panama, Brazil, Colombia, Philippines, Uruguay, Indonesia, and Romania carry lower sovereign credit ratings but boast lower CDS and dollar bond yield premia over Treasuries. Russia and Turkey have lower average ratings than South Africa but their debt and CDS spreads are roughly on the same level.
So a ratings cut is unlikely to trigger huge outflows from South African debt markets, says JPMorgan, which runs the most widely used emerging bond indices. In Brazil for instance, a well-anticipated downgrade back in March did not lead to significant cash outflows from its markets, JPM points out:
The current relationships between spreads and ratings do not necessarily imply another step wider in South Africa’s spreads until it is firmly sub-investment grade (not J.P. Morgan’s base case).
Secondly, even after a downgrade to BBB-, South Africa would still be rated investment grade, so investors will not be required to sell their holdings. On local currency debt, South Africa is rated A- from S&P so a 1- or even 2-notch downgrade should have no technical impact the bank argues.