Eskom’s Blackouts Could Be a Knockout for South African Rand

JOHANNESBURG (Capital Markets in Africa) The rand has become the whipping boy for investors concerned about South Africa’s struggling electricity utility and its impact on the country’s economy.

After posting the best start to a year on record on January, the currency is heading for its biggest February loss since Bloomberg started compiling the data in 1989. Eskom’s bonds, meanwhile, are behaving as if there’s no problem, even as traders fret about the government’s ability to rescue the state-owned company from its mire of operational and financial challenges.

The rand is already down 6.7 percent this month, easily the worst performanceamong emerging-market currencies. And the cost of hedging against further declines is climbing, with the premium of contracts to sell the currency over those to buy it, known as the 25 Delta risk reversal, widening to the most since September. The rand weakened 0.2 percent to 14.1490 per dollar by 4:30 p.m. in Johannesburg.

Finance Minister Tito Mboweni’s maiden budget on Wednesday will be make-or-break. Investors want to see a deficit-neutral plan that provides financial relief for Eskom while setting out longer-term steps to fix operational problems that led to rolling blackouts in recent weeks. That’s a tall order — especially with elections looming in May — but anything less will increase the chance of a credit-rating downgrade and provide more reason to sell the rand.

Yields on Eskom’s dollar bonds show no sign that investors are concerned about repayment. The yield on $1 billion of 2028 notes dropped 30 basis points since the start of the year and is near a record low. Yields on government rand bonds, however, tell a different story. The benchmark 2026 yield has climbed 28 basis points this month, approaching a level where it is pricing in the risk of a sovereign debt downgrade, according to Nedbank Group Ltd.

That’s because investors expect a government bailout for Eskom, which has state guarantees for more than half its debt anyway. But any bailout that results in a deterioration of the government’s fiscal metrics will ring alarm bells, not least with Moody’s Investors Service, the only major rating company still to assess South Africa at investment level.

“Any transfer of Eskom debt to the state budget without the context of central rationalization on the company’s cost structure would set a dangerous precedent,” said Luis Costa and Dumitru Vicol, London-based analysts at Citigroup Inc., which pulled out of short dollar-rand positions this week. “That could trigger an acceleration of the path towards a downgrade. A lot of price action in the following two to three months will depend on the government’s reaction function in the next week or so.”

Moody’s, which rates South Africa’s debt at Baa3, the lowest investment level, is due to assess the rating on March 29. S&P Global Ratings and Fitch Ratings downgraded the country to junk in 2017, and if Moody’s follows suit that would trigger the exclusion of rand bonds from the Citigroup’s World Government Bond Index, sparking outflows of as much as $10 billion, according to Investec Bank Ltd.

South Africa’s credit-default swaps already trade higher than Brazil, which is rated one step lower at junk by Moody’s. That suggests traders are pricing in the probability of a credit downgrade for South Africa.

“A massive overhaul of Eskom would be positive in the medium term, but we believe that is unlikely to materialize ahead of the May election,” said Marek Drimal, a London-based strategist at Societe Generale SA, who recommends shorting the rand on any rally below 14 per dollar. “Eskom’s problems are likely to drag on, resulting in more blackouts and further undermining business confidence and investment.”

Source: Bloomberg Business News