April 30, 2020 / 3:07 PM / a month ago

Local investors cushion impact of South Africa bond index exit - for now

* South Africa exits WGBI after Moody’s downgrade

* Foreigners sell $3.2 bln govt bonds year-to-date

* Bonds still sought-after among local investors

* Longer term, focus shifts to COVID-19 fiscal shock

By Alexander Winning and Tom Arnold

JOHANNESBURG/LONDON, April 30 (Reuters) - South Africa’s exclusion from a major global bond index on Thursday appears to have been a less severe blow than expected, with foreign investors having been given a full month’s warning to exit the market and local investors stepping in to buy.

But if the bonds have so far avoided a sudden shock, they remain vulnerable to a plunge in sentiment because of the impact of the coronavirus on an already vulnerable economy.

South Africa lost its last investment grade rating in March, forcing it to be excluded from the World Government Bond Index (WGBI) on Thursday. That means some large overseas funds will no longer be able to hold the country’s debt.

Analysts had predicted that exiting the index could lead to at least $5 billion of forced selling of the government’s rand-denominated bonds, based on its weight in the roughly $1 trillion index.

But with the downgrade arriving on March 27 in the midst of the coronavirus market rout, index provider FTSE Russell decided to postpone its WGBI rebalancing until the end of April. That meant investors had plenty of time to adjust their portfolios and avoid an abrupt exit.

Local asset managers do not expect a severe sudden blow, partly because so much foreign selling has already happened: finance ministry data shows foreign investors have already sold 57 billion rand ($3.2 billion) of bonds this year.

Meanwhile, local investors have stepped in, said Nolan Wapenaar, co-Chief Investment Officer at Anchor Capital in Johannesburg, pointing to an auction of a 2026 instrument on Tuesday which saw bids of more than eight times the amount on offer.

Giulia Pellegrini, senior portfolio manager at Allianz Global Investors in London, said some emerging market (EM) investors still took a shine to South African debt.

“The relative attractiveness of South African local bonds to other EM peers as well as the depth of the South African domestic market ... helps cushion this exclusion,” she said.


South Africa joined the WGBI in 2012, becoming the first and only African government bond market in the index.

Getting kicked out is a severe symbolic blow. But with the coronavirus now dominating investment decisions, it is no longer perceived as the game-changing event it might once have seemed.

Wikus Furstenberg, portfolio manager at Futuregrowth Asset Management in Cape Town, said economic fundamentals, rather than membership in an index, were the big issues.

“We don’t know how bad the recession will be,” he said. “South Africa started this crisis in a vulnerable fiscal position, and it’s not getting better.”

Africa’s most industrialised nation was already predicting a budget deficit of almost 7% of gross domestic product (GDP) before the new coronavirus struck. Now this year’s deficit will probably reach double that, economists say.

That could push its debt-to-GDP ratio close to 80% compared to around 50% as recently as 2016.

“That is uncomfortable. That is saying the yield curve should continue to steepen and explains why the government is selling more short-dated bonds, because the longer-term bonds are going to battle to sell,” said Anchor Capital’s Wapenaar.

After South Africa’s exit, attention could shift to Mexico, whose investment-grade credit ratings are seen under threat.

The WGBI is dominated by developed markets but Poland, Malaysia and Israel from May are also part of the index.

$1 = 18.0740 rand Reporting by Alexander Winning in Johannesburg and Tom Arnold in London Editing by Karin Strohecker and Peter Graff

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