Maseru- Metropolitan Lesotho says local pension funds are set to be affected by the recent downgrading of South Africa’s (SA) credit rating as 65 percent of Lesotho’s pension fund assets are invested on the Johannesburg Stock Exchange (JSE), this according to the investment company’s analysts.
Business Development Manager at Metropolitan Employee Benefits Division Seenyane Nthejane and Sepinare Lenkoe, General Manager at Metropolitan Health say investors should expect turbulence in the short to medium term, with the long term expected to adjust in line with SA’s economic performance.
The Metropolitan analysts say the current developments in SA affect Lesotho directly as a result of changes in SA’s executive leadership. SA president, Jacob Zuma, fired Finance minister Pravin Gordhan, alongside eight other cabinet ministers in a major reshuffle recently resulting in an upheaval of the economic and political situation in that country.
Standards and Poor (S&P), an international ratings agency, thereafter released their latest review on the SA economy. The agency has downgraded South Africa’s long-term foreign currency from the lowest investment grade (BBB-) to a sub-investment (BB), popularly known as “junk status”.
“It also dropped the country’s long-term currency rating from BBB to the lowest investment grade (BBB-) with S&P maintaining its negative outlook on SA because it believes the political risk will continue to remain elevated throughout the year,” they noted.
S&P also downgraded all South African Banks to junk status in line with the sovereign downgrade. This was due to the fears that there could be some policy shifts which could undermine SA’s growth and fiscal outcomes relative to the current forecasts.
The two analysts further say, “There are two primary risks that investors are now facing as consequences of the ratings downgrade, mainly lower returns due to stock market valuations declining, as well as the risk of negative real returns in the short term”.
The downgrade for the banks is expected to lead to declines in their stock prices as well as increased borrowing costs, which will affect their financing as well as dividend policies in the short term, which will consequently lead to lower returns for JSE investors with exposure to the financial sector.
Looking at the above, Seenyane and Lenkoe said the risk is apparent of negative real returns in the short term, as lower returns coincide with higher inflation. However, assuming the fundamentals remain the same and policy trajectory doesn’t change, they say consumers should expect an eventual uptick in the economy and returns, as rand depreciation will likely result in export led growth due to rand denominated products now being cheaper for overseas consumers.
“There is also an anticipated capital flight from International institutional investors, which will have a twofold impact on investors, the first being the decline in the Rand, which will have implications for the inflation rate, as well as suppressed demand for South African Stocks and Government bonds, which will also affect stock valuations.
“The likely inflation rate increase is expected to lead to Interest rate hikes in the short to medium term, leading to lower investment by business as well as lower disposable income for consumers who have debt and face increased debt costs, these events will likely then lead to suppressed economic activity, and have a feed through to the overall stock market valuations and returns,” a statement from the company reads.
Giving a background of the events that led to, Nthejane and Lenkoe explained that South Africa is part of Citibank world government bonds index and its sustained inclusion in this association is currently questionable.
To be part of this association, one of the requirements is that the country must have an investment grade by either S&P or Moody’s. If Moody’s downgrades SA foreign and local currency ratings to sub-investment grade, South Africa will removed from this association and this will have negative impacts on the country’s currency and economy.
In addition to that foreigners own around one-third of all outstanding SA government bond and it is expected that if SA is removed from Citibank world government bonds, foreigners would sell the SA bond holdings. It is said that the outcome from this would drive the rand weaker which will hike both inflation and interest rates higher of which during this period global asset classes will be performing better than SA’s asset classes.
“With the interest rate hikes, cash and equities especially shares with large global revenue bases will outperform fixed income investments (for example bonds),” they noted.
“In looking at the likely impact of these developments on your investment performance in the short to medium as well as the long term, a few caveats are worth noting, first long term implications are based on the assumption that the South African government will maintain good fiscal policy and refrain from populist hyper-inflationary policies. Secondly the economy is a system and therefore the analysis is based on current conditions prevailing in the near to medium term, and finally we have restricted the analysis only to factors that have a direct bearing on investment returns,” they said.