Credit Woes Come Calling For The South Africa ETF

In a year in which precious metals prices are pushing higher, it would be reasonable to expect that equities in South Africa, a major producer of those commodities, would be following suit.

For the most part, that hasn't been the case as the iShares MSCI South Africa ETF EZA is higher by just 4.26%, less than half the 10% returned by the MSCI Emerging Markets Index.

The Reserve Bank of South Africa has been cutting rates this year to prop up a flailing economy, Africa's largest, but that isn't doing much to allay credit concerns by the major ratings agencies. Last Friday, Standard & Poor's lowered its outlook on South African sovereign debt to “negative” while maintaining a junk rating of BB.

Why It's Important

“We could lower the ratings if we were to observe continued fiscal deterioration,” S&P said in a statement.

That comment came just a month after the ratings agency said there was no immediate pressure on South Africa's rating and just a few weeks after Moody's Investor's Service also cut its outlook on the country's credit rating.

“Moody’s lowered the outlook on its investment grade rating to negative less than three weeks ago, effectively giving the nation three months to get its finances in order,” reports Bloomberg. “A Moody’s downgrade would force South Africa out of the FTSE World Government Bond Index, which could prompt a sell-off and outflows of as much as $15 billion, according to Bank of New York Mellon Corp.”

If Moody's lowers its rating on South Africa, the ratings agency would take the country into junk territory, meaning higher financing costs and bonds issued with higher interest rates to compensate investors for elevated risk.

What's Next

For U.S. investors engaged with emerging markets bond ETFs, if South Africa's credit rating is lowered, the impact could be negligible because the country doesn't account for significant percentages of those funds. For example, the widely followed J.P. Morgan EMBI Global Core Index allocates just 2.92% of its weight to South African debt.

Some equity investors are willing to take the risk. Since the start of the fourth quarter, investors have added $19.37 million to EZA. The South Africa has a three-years standard deviation of 21.06%, or nearly 700 basis points above the MSCI Emerging Markets Index.

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