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​Investors already pricing in ratings risk

A downgrade to sub-investment grade unlikely to translate into ‘a massive blowout’ in terms of the rand – Nomura Bank economist.

Any downgrade is unlikely to take place before the ANC national conference in 2017 – when the new leaders are elected to head the ruling party. Even then two ratings agencies would need to rate SA with junk status before global pension funds invested in bonds would be forced to divest.

Peter Attard Montalto, a specialist adviser on South Africa with Nomura Bank in London, told the Cape Town Press Club on the weekend that he was not going to present a gloomy picture of South Africa, as painted by one or two other analysts.

In the short term, he said he is actually bullish about the rand; he believes that a conservative stance of the South African Reserve Bank (Sarb) works as “a backstop” on the rand.

But it is expected that the monetary policy committee will next month raise interest rates by 25 basis points, “and I believe rates will be up to 7.50 at quarter three next year”.

While this is unfortunate, “for you who have mortgages or whatever… that acts as a big backstop” particularly if one compares the SA currency with that of the Turkish currency.

Montalto expects the Turkish central bank to behave in a very different way to the Sarb. “The Sarb has taken a very diligent and obvious view…it is not their job to lift growth…it sounds completely obvious (but) they have to say it.”

The Sarb sees the latter as the job of government while “they have to fight their fear around inflation”, which he said does worry him quite a lot “through next year … the hikes that will come [to fight inflation]”. Investors, he believes, have already priced in any ratings agency devaluation “which can’t really happen before 2017”.

He acknowledged that by then debt levels will probably be “over 50% of GDP” – it is a consensus that 60% is probably a tipping point – and contingent liabilities would probably be a lot higher “given [the troubled] Eskom and other parastatals particularly SAA (South African Airways).”

“I already think that the markets are pricing South African risk a little bit below where it is at the moment… the theoretical market price rating is a little below where it actually is… investors ultimately make [up] their minds beforehand.”

This is why there will likely be a steep yield curve in South Africa and why real interest rates “over the long run will be quite high from the Sarb”.

Much of the shift in the rand over the last three years reflects that there “has already been pricing in of some of this story” – a possible downgrade – ahead of time.

In addition two ratings agencies, like Moody’s and Standard & Poor’s, would need to downgrade SA to sub-investment grade before “various institutions around the world will be forced not to buy South African debt”. In the longer term, “before an actual downgrade (you will) start to have a gentle weakening of the rand”, he advised.

Montalto believes there remains “a huge amount of goodwill” towards South Africa’s financial and fiscal institutions – notably the National Treasury and Sarb – and the “broad fiscal picture is given the benefit of the doubt”. However, ratings agency expectations have been “built up to the biggest they can be” and there can only surprise “on the downside now”.

Predicting that investment in the mining and agriculture sectors are likely to pretty much bumble along, he said there is significant “brown investment” in mining – to keep plants going but green investment is “basically zero”.

There is still the potential that if SA moved to a highly mechanised environment, the mining sector could do “extremely well” but there is not yet the right political mindset to underpin this. He believes SA will ultimately get there, however.

Even though there are threats of placing agriculture land under State custodianship in SA – avoiding the need to pay compensation for farm land – he believes the ANC will be cautious about the introduction of this programme.

This is a “very uncertain model.. farmers may be compensated from rent recovery through the process and establishment of market value”. Land provided to new farmers would take it in trust and they would be expected to pay “a certain rent to original farmers” who would enjoy leasehold rights.

He believes, however, the ANC would be cautious on this policy – still in draft form – “as it will not (wish to) sacrifice food security”.

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