Emerging Markets

South Africa is facing a trip to a junk credit rating, but it's not all doom and gloom

City of Johannesburg, South Africa
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Can South Africa, the country that put the "S" in BRICS — the acronym for the best and brightest emerging market economies — escape a trip to the junk heap? It's unlikely that it can.

In this case, "junk" refers to a downgrade of South Africa's sovereign credit rating to below investment grade as the G-20 country has been under pressure amid endless political turmoil and the spillover effect on its economy. As official growth forecasts have been slashed, all indications are that South Africa may yet see its credit rating hit speculative status sooner rather than later.

According to economy watchers, investors are beginning to price in junk status for the beleaguered BRICS nation, where Finance Minister Pravin Gordhan was recently summoned to appear in court over fraud allegations as he fights to keep the country on track.

S&P, Fitch and Moody's Investors Service all have the lowest rung of investment grade assigned to South Africa's sovereign rating. In May, Moody's slapped the country with a negative outlook, warning the government was facing structural challenges to economic reforms.

As a result, analysts are all but counting the months until South Africa's rating gives way. Ratings agencies may cut by year's end, "though it is possible some may wait and see until early 2017," Win Thin, global head of emerging market currency strategy at Brown Brothers Harriman said in an interview.

He added that "downgrades by all three agencies are warranted," despite the fact that investors appear to have been purchasing South African assets with enthusiasm in recent weeks.

The buying spree underestimates mounting political risk gripping the country that is "likely to cement a downgrade to sub-investment grade," Thin wrote in a note to clients in October.

'The odds are long'

South African President Jacob Zuma
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South Africa has been one of the more widely held credits across the spectrum through the year, including bonds, currency and local interest rate products. It has also been one of the beneficiaries of flows out of Turkey, which itself was downgraded in the wake of a failed coup in July.

Now, it's South Africa that's being buffeted by political tumult. President Jacob Zuma is under intensifying pressure to step down after an anti-corruption watchdog called for a judge to investigate allegations of influence peddling in Zuma's government, which he has denied.

"While obviously not the same risk, Turkey and South Africa have similar profiles," said Nishant Upadhyay, head of emerging markets debt at HSBC Global Asset Management.

A downgrade may have some ripple effect because its assets are held by a variety of investors, Upadhyay said. Yet if South Africa's rating is cut, repercussions to its regional peers should be limited.

"I do not think there would be much impact beyond some sympathetic widening in African countries, most of which are already rated below investment grade," Upadhyay said.

"There is some small likelihood that Morocco might see flows, being the rare [investment-grade] country in the area," he added.

Meanwhile, South Africa's economy is barely moving in the right direction, with current growth mired near its lowest in about seven years. Last month, Gordhan delivered a closely watched midterm budget address, which analysts say are initiatives to keep the global ratings agencies at bay — and stave off another downgrade.

Political infighting and low growth are both key factors why ratings agencies have the country at the levels in which they do, and Gordhan, Thin says, is aware of the damage "junk" status will do to the country. A proposed increase in tax revenue is expected to bring in more than $3 billion over the next two years.

Right now, higher interest rates on its bonds are luring some in, but more downgrades would lead to forced selling. President Jacob Zuma "should reassure markets that he is not trying to get rid of ... Gordhan, and then he should fully embrace austerity," Thin told CNBC.

Can it be done, given the politics? "Possibly, but the odds are long," Thin said.

--Reuters contributed to this report