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This Emerging Markets ETF Could Have to Endure A Credit Downgrade

October 22, 2015 9:58 am
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This Emerging Markets ETF Could Have to Endure A Credit Downgrade

It has been less than a month and a half since Standard & Poor's stripped Brazil of an investment-grade credit rating, sending Latin America's largest economy to junk status. Since then, market participants have speculated about which emerging market will be next to lose an investment-grade rating.


As some recent media reports suggest, the emerging markets patch has plenty of candidates that could suffer ratings downgrades, including Turkey. In May, S&P downgraded its rating on Turkey's lira, one of this year's worst-performing emerging markets currencies to "BBB-/A-3" from "BBB/A-2.” At the time, the ratings agency said there is in a one-in-three chance it could downgrade Turkey's sovereign in six to 12 months


Turkey may have some competition from South Africa for next emerging market to see its sovereign credit rating sent to junk. With the iShares MSCI South Africa ETF (NYSE: EZA) down 17 percent over the past six months, it is easy to see why.


“South Africa took a step closer to another credit-rating downgrade as a slowing economy forced Finance Minister Nhlanhla Nene to boost debt at the same time that mounting spending pressures fueled protests against the government,” reports Bloomberg


S&P currently rates debt issued by South Africa, Africa's second-largest economy behind Nigeria, BBB-, the lowest investment grade. Fitch Ratings rates South African bonds BBB while Moody's Investors Service has a Baa2 rating on South Africa. Moody's and S&P have stable outlooks on their ratings of South African debt while Fitch has a negative outlook.


Looking at the performances of the ETFS Physical Platinum Shares (NYSE: PPLT) and the ETFS Physical Palladium Shares (NYSE: PALL) explains some EZA's woes this year. Those precious metals are down an average of 16.5 percent year-to-date and that is bad news for the South African economy because the country is the world's largest platinum producer and the second-largest palladium producer behind Russia.


The $408.2 million EZA is not significantly exposed to those swooning metals as the materials sector accounts for just 5.5 percent of the ETF's weight. Five other sectors command bigger weights in the lone South Africa-specific ETF.


Still, EZA and South Africa face other risks to retention of an investment-grade credit rating, namely massive unemployment. In May, South Africa's jobless rate hit an 11-year high at 26.4 percent before falling to 25 percent by the end of the second quarter. At 25 percent, South Africa's unemployment rate is nearly triple that of Brazil's.

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