Bloomberg News

South Africa’s Credit Rating Cut Amid Mining Strikes

October 08, 2012

Strikes spread in Africa's Biggest economy

Striking miners celebrate after securing a 22 percent pay hike from London-listed Lonmin platinum mine in Marikana on September 18, 2012. Photographer: Alexander Joe/AFP/Getty Images

South African government bonds were the worst performers last week as spreading labor unrest, the first rating downgrade since apartheid and a widening trade deficit overshadowed the debt’s inclusion in a benchmark index.

Securities due in a year or longer lost 3.9 percent for dollar investors, with debt maturing in more than a decade retreating 4.9 percent, the biggest drop among 26 sovereign bond indexes compiled by the European Federation of Financial Analysts Societies and Bloomberg. The yield premium on rand- denominated notes over U.S. Treasuries rose to a one-month high, even after the debt was included in Citigroup Inc. (C:US)’s World Government Bond Index.

Strikes have spread from mines to the road-freight industry since protests that began Aug. 10 at Lonmin Plc (LON) resulted in pay increases of as much as 22 percent. Port and railway workers may join, threatening to curb tax revenue as the government struggles to contain spending that prompted Moody’s Investors Service to cut South Africa’s debt ratings.

“The negative headlines we have seen have totally overtaken and offset any possible positive momentum coming from the WGBI inclusion,” Benoit Anne, the head of emerging-market strategy at Societe Generale SA, said by phone from London on Oct. 5. “It’s an unfortunate turn of events. From a markets perspective, this inclusion into the WGBI, which should have been celebrated by the market, was in fact a non-event. The prevailing forces are on the negative side right now.”

Foreign Buying

Foreign investors bought 42.8 billion rand ($5 billion) of South African bonds from Sept. 28 to Oct. 4, according to data supplied by JSE Ltd., operator of the country’s stock and bond exchanges. An estimated $2.75 billion of the buying through Oct. 2 was by foreign funds with as much as $3 trillion in assets that track the Citigroup gauge, Leon Myburgh, the bank’s sub- Saharan strategist, said in a note to clients on Oct. 4. Net purchases totaled 8 billion rand through Oct. 4 as some foreign investors who had bought bonds before their inclusion into the index, sold the debt.

Foreign investors bought a net 84 billion rand in government and corporate bonds this year, the most on an annualized basis since at least 1996, according to JSE data. Net purchases stood at 17.5 billion rand on April 16, the day before Citigroup announced South African debt may be eligible for WGBI inclusion. Buying levels of the bonds were unsustainable, Reserve Bank Governor Gill Marcus said on Oct. 3.

Sell-Off

“WGBI if anything helped dampen the potential sell-off because of the amount of money that came into the county,” Myburgh said in an Oct. 5 phone interview. “The news flow has been bad and you’ve picked it up in the rand particularly.”

The rand fell as much as 3.8 percent to 8.8465 a dollar on Oct. 5 and traded 1 percent down at 8.8690 by 11:15 a.m. in Johannesburg, its weakest on a closing basis since April 23, 2009. The currency has declined 8.8 percent this year.

Yields on the government’s 6.75 percent bonds due March 2021 rose 21 basis points to 6.93 percent, the biggest increase on a closing basis since September 2011. The yield premium over 10-year U.S. Treasuries increased almost six basis points, or 0.6 percentage point, to 500 basis points on Oct. 5, after reaching a 502 on Oct. 1, the biggest gap since Sept. 5.

Rating Cut

Moody’s lowered South Africa’s credit rating by one level to Baa1 on Sept. 27 and retained its negative outlook on the nation’s debt, saying the country’s budget deficit is giving it less fiscal room to stimulate the economy and worsening revenue prospects among the reasons for its decision. Standard & Poor’s, which also has a negative outlook on the nation’s debt, said in a statement a day later that news flow from the country hasn’t been good and risks haven’t eased.

Truck drivers went on strike on Sept. 24, causing a third of the gasoline stations in Gauteng province, South Africa’s commercial hub, to run dry last week, an industry body said. A shortage of fruit trucked from the southwestern region boosted prices at the Johannesburg Fresh Produce Market, said Paul Botha, a market agent.

The yield gap between five-year fixed-rate bonds and similar-maturity inflation-linked notes widened 13 basis points to 5.6 percentage points on Oct. 5, the widest since Aug. 17, a signal that investors are increasing bets that consumer prices will rise. The inflation rate climbed for the first time in four months in August, accelerating to 5 percent from 4.9 percent in July.

Deteriorating Fundamentals

The biggest current-account deficit in four years is at risk of widening as exports from Africa’s largest economy decrease. The shortfall increased to 6.4 percent in the second quarter and may increase further after the trade gap jumped to the highest in seven months in August. The current account is the broadest measure of trade in goods and services.

South Africa has “some deteriorating domestic fundamentals to deal with, starting with a record current-account deficit and a trade account that has blown out towards record levels recently,” Quinten Bertenshaw, an analyst at ETM Analytics in Johannesburg, wrote in an Oct. 5 report to clients. “It would be ‘‘disingenuous to suggest that all of the rand’s movement was related to disappointment around the level of WGBI flows.’’

‘‘The impact of strike action on tax revenue cannot be positive and will increase the probability of the government missing its fiscal targets,’’ John Cairns and Josina Solomons, currency strategists at Rand Merchant Bank in Johannesburg, wrote in e-mailed comments to clients on Oct. 5.

Debt Pledge

Finance Minister Pravin Gordhan is struggling to keep spending in check to control the budget deficit. He has pledged to reduce the budget deficit to 3 percent of gross domestic product by the year ended in March 2015 from 4.6 percent this year. Gordhan is scheduled to give revised revenue and spending targets at a mid-term budget on Oct. 24.

The cost of insuring South Africa’s debt using credit default swaps over five years surged nine basis points to 162 on Oct. 5, the highest since June 29, indicating a deterioration in risk perceptions. Similar contracts for Mexico, which has the same Moody’s rating, dropped two basis points to 99.5. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if the government fails to adhere to its debt agreements.

South African debt maturing in one to three years lost 3.2 percent in the five days through Oct. 5, compared with a 1.7 percent decline in similar-dated Australian securities, the next worst performer, according to Bloomberg and EFFAS indexes.

The inclusion in WGBI may have been ‘‘counterproductive” as investors bought bonds before the event, Societe Generale’s Anne said.

“Now the risk is turning around, with the negative headlines, you face the risk of capital outflows,” he said. “It’s a make or break situation right now. I’m still hoping we are facing a fantastic buying opportunity.”

To contact the reporter on this story: Stephen Gunnion in Johannesburg at sgunnion@bloomberg.net

To contact the editor responsible for this story: Vernon Wessels at vwessels@bloomberg.net


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