Fitch Ratings said that the South African rand’s (ZAR) 19% year-on-year fall against the US dollar will increase leverage and reduce interest coverage ratios for some Fitch-rated South African corporates and state-owned enterprises (SOEs).
However, the ratings agency (CRA) believes that credit impact will be mitigated by widespread use of hedging strategies and by South Africa’s deep local bond market, which limits the overall level of foreign-currency debt.
As well as increasing import prices, depreciation can create significant risks for companies whose debts and revenues are in different currencies. For South African corporates, the adverse impact of the ZAR’s decline may be exacerbated in the short and medium term by increased domestic interest rates and rising inflation. This will increase pressure on consumers and corporates alike. While importers and companies with foreign currency debt are most exposed to ZAR depreciation, exporters generating largely foreign currency revenues such as Sappi Southern Africa and those with minimal or no foreign currency debt are likely to benefit.
Transport and utility companies face some of the highest risks as over 27% of their debt is denominated in foreign currencies, while the majority of their cash flow is in ZAR, says Fitch. In the near term, however, this is partially offset by the use of hedging to reduce foreign exchange (FX) risk exposure.
Electricity public utility Eskom, for example, hedges all foreign currency exposures above ZAR150,000 and 86% of its total debts as at FYE13 were at fixed interest rates. Rising input prices are also a risk for these sectors, with Eskom exposed to price risk on the diesel it uses to generate electricity which is driven by the dollar oil price.
The ratings of state-linked South African utilities, however, benefit from our expectation of timely support if needed, notably for Eskom, Rand Water and Umgeni Water. The currency depreciation on its own is therefore unlikely to lead to downgrades. Transnet is rated on a stand-alone basis, with 34% of its debt in foreign currency, all of which is hedged to maturity.
For South African issuers operating in many countries, the level of foreign currency debt is even higher – often above 60%. However, Fitch says these companies generally do a good job of matching foreign currency debt and cash flow. This creates a natural currency hedge, which, in addition to employing hedging strategies, limits vulnerability to short-term currency devaluation. For example, multinational media company Naspers generates about 42% of its revenues in foreign currencies, while about 46% of its cash reserves were held in foreign currency at FYE13. Mobile operator MTN generates 69% of its revenue in foreign currencies with 61% of its debt being foreign currency denominated.
South African corporates also benefit from a deep local bond market, making it possible for corporates and SOEs to borrow in local currency at relatively long maturities, although rising domestic interest rates would raise funding costs across the board. In November 2013 Transnet become the first South African company to list a ZAR5bn rand-denominated bond on the international capital markets – a trend which could continue amid rising bond yields.
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