Is South Africa edging out Turkey as the big EM short?
* Rand a natural play on trade war tensions due to China
* Lacklustre growth putting pressure on already-strained
* Moody's seen putting last investment grade rating on
* Downgrade would see S.Africa bonds ejected from crucial
By Marc Jones
LONDON, June 20 (Reuters) - Move over Turkey and Argentina,
emerging markets investors have another country to sweat over:
The most industrialised economy in Africa was among the
"Fragile Five" emerging markets identified by analysts as long
ago as 2013 and it has struggled since with reforms to spur
growth, including to state firms like power utility Eskom.
But things now seem particularly precarious. Unemployment
has reached a 15-year high of 27%, while the economy contracted
by 3.2% in the first three months of 2019 -- the biggest
quarterly slump in a decade.
On top of that, some politicians now want to tinker with the
central bank's remit, while South Africa's largest trading
partner, China, is being dragged deeper into a trade war with
the United States.
"There has been a confluence of negative news for South
Africa recently," said Bank of America Merrill Lynch strategist
David Hauner, who reckons the rand is now the most-shorted
(bet-against) emerging market currency.
That is largely because it is used as a liquid proxy for the
Chinese yuan. "It makes a lot of sense because China is the
country's biggest trading partner," Hauner said, noting that
South Africa's time zone also means the currency is tradable in
Asia, Europe and the Americas.
This week could be a key one. President Cyril Ramaphosa
gives a 'State of the Nation' address on Thursday in which he is
widely expected to announce more measures to support ailing
Eskom. He also needs some fresh ideas on how to bring down a
government deficit projected to rise to 4.5% of GDP this fiscal
That will all influence another critical issue -- the fate
of South Africa's last remaining investment-grade credit rating.
Oxford Economics now ranks South Africa behind Turkey and
Argentina as the big emerging market most at risk of a debt
crisis, which warrants downward pressure on its rating, said
Evghenia Sleptsova, an economist at the firm.
Expectations are growing that Moody's will cut South Africa
to "junk" from a current Baa3 before year-end -- or at least
issue a downgrade warning, as Societe Generale predicts will
happen at Moody's next scheduled review on Nov. 1.
Just the fear that a country will slip from investment-grade
into the "speculative" category can have a severe market impact.
In the five months before S&P removed Brazil's remaining
investment-grade rating in 2015, the real lost 30% of
its value against the dollar, while Turkey's lira slumped 25%
in four months before Fitch cut it to junk in 2017.
A full set of junk ratings can trigger the ejection of a
country's bonds from the global fixed income indexes used by big
money managers, forcing them to sell and pushing up borrowing
costs for the government.
Societe Generale has estimated in the past that being booted
from both the FTSE World Government Bond Index (WGBI) and the
Bloomberg Barclays Global Aggregate could trigger sales of South
African debt worth between $6 billion and $17 billion.
"The quarterly decline (in the economy), the largest in 10
years, is credit-negative," Moody's lead South Africa analyst
Lucie Villa warned bluntly this month. For the year as a whole,
GDP is expected to grow only 1%.
THE BIG SHORT
More than 85% of South African government debt is in rand,
helping shield it from exchange-rate shocks.
Foreigners hold almost 40% of it though, and with the
currency down 20% since February, it looks like some have
already been selling: a year ago that figure was 43%.
"I am underweight (South Africa debt and the rand) and have
been for some time," said Edwin Gutierrez, head of emerging
market sovereign debt at Aberdeen Standard Investments.
"The bond position is not disastrous because you have the
possibility of interest rate cuts, but the tricky thing is the
rand and whether you can effectively hedge it."
Reuters polls had predicted a modest rand bounce later in
2019, but the shock Q1 growth reading may cause a revision.
Societe Generale analysts see the rand dropping to 15.4 per
dollar by year-end from 14.8 now, and to 16 by mid-2020.
BAML's latest positioning survey flags it as the
most-shorted EM currency when 'real money' and 'higher
frequency' funds are added together, whereas there are now
modest longs on both Turkey's lira and Argentina's peso.
That is despite the rand registering as 10% undervalued on a
real effective exchange rate (REER) basis, calculated as its
10-year weighted average value against a basket of currencies.
Argentina's peso has a similar REER reading while the lira
notches up an almost 30% undervaluation.
"Sentiment (towards South Africa) is quite poor but it
hasn't really sold off to the extent Turkey did when it was
really moving," said North Asset Management portfolio manager
Peter Kisler. "If things start to snowball though, volatility
could really pick up."
($1 = 14.7800 rand)
(Reporting by Marc Jones; Additional reporting by Karin
Strohecker; Editing by Catherine Evans)
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