The South African rand dropped sharply against the USD and bonds depreciated as Moody's Investor Services announced its intention to reduce its outlook on the country's sovereign debt rating. The rating agency cited growth and deficit concerns as reasons for the decision.
The rand, which had appreciated substantially in recent weeks, immediately dropped 1.5 percent in value and is currently trading at around 8.00 to the USD. This was the biggest drop in a single day since the beginning of November.
The yield on 13.5 percent government bonds, which are due in 2015, also increased 11 basis points and now stands at 6.5 percent. The yield on the $2bn worth of South African government bonds due in 2020 also increased by 1.86 percent (23 basis points). Higher interest rates on government bonds reflect the increased risk investors associate with them.
Moody's decision to reduce its outlook on South Africa's A3 rating on local currency and long-term currency debt is the result of fears that the country's annual growth rate will be lower than initially estimated and that the country's government will be unable to meet its commitment to cutting budget deficits, as a result of popular pressure.
On October 25, Pravin Gordhan, who is South Africa's finance minister, announced that the budget deficit for the year ending March 31 would, in all likelihood, be 5.5 percent of the country's GDP, compared to 4.6 percent of the previous year.
Gordhan is in a particularly difficult position, on the one hand he is attempting to keep the budget deficit as low as possible, but on the other he is facing enormous pressure from a range of groups that includes trade unions and the ANC youth league, to increase social spending and job creation.
A currency strategist based at Standard Bank Group Ltd, in Johannesburg, Nomvuyo Guma, said in a telephone interview with Bloomberg, “Lowering the outlook is generally a precursor to a credit downgrade, which would certainly be a risk to inflows into the bond market, You've already seen the reaction in the markets.”
The South African Government strongly disagrees with Moody's decision and expressed ‘disappointment', in an email statement issued by the National Treasury. The statement claimed that the two main reasons behind Moody's decision were the global economic situation and that the country's public revenue would increase the moment growth prospects improved.
A fixed-income analyst attached to Afrifocus Securities, Michael Grobler, speaking in Cape Town, said that the South African market's “direction is influenced by the weakening of Italian bond yields.” He described the outlook cut by Moody's as “a setback for the current bond rally.”
To what extent Moody's decision would become a self-fulfilling prophecy, only time will tell. There is little doubt that a general aversion to developing country debt played a major role in the rating agency's decision.