South Africa ETF Still Faces Credit Concerns

The iShares MSCI South Africa Index (ETF) (NYSE:EZA) is up 11.4 percent year-to-date, good for one of the admirable performances among single-country emerging markets exchange-traded funds, but EZA's showing should not be interpreted as a sign of easy money.

South Africa is the world's largest platinum-producing country and the second-largest palladium producer behind Russia. That is to say, although the materials sector is not a significant part of EZA, price action in those metals looms large for South African equities.

=Second, investors, to the extent that they can be, appear comfortable with the fact that South Africa could very well be the next emerging market to suffer a sovereign credit downgrade at the hands of one of the major ratings agencies. Maybe Turkey will beat South Africa to that dubious punch, but a rating downgrade is still on the table for Africa's second-largest economy.

Rating Downgrade In The Cards?

Speaking of ratings downgrades, Fitch Ratings pared its outlook on South Africa's sovereign credit rating to negative from stable while affirming the sovereign rating at BBB-. Politics are among the risks to South Africa's credit rating.

Political risks to standards of governance and policy-making have increased and will remain high at least until the electoral conference of the African National Congress (ANC) in December 2017, negatively affecting macroeconomic performance. The conference will elect a new ANC leader, who will be the ANC's presidential candidate in national elections in 2019, said Fitch in a recent note.

Current Ratings, Economic Situation

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.

The South African economy may have started recovering from a series of shocks, but business confidence remains depressed and investment has continued to contract. We expect only modest GDP growth of 1.3 percent in 2017 and 2.1 percent in 2018, although this is an improvement from 0.5 percent in 2016. The economy had been hit in 2015 and 2016 by electricity shortages, the worst drought in decades, a sharp fall in international prices for some of South Africa's main mining commodities and rising policy uncertainty, added Fitch.

South Africa's unemployment remains staggering at just over 27 percent, which applies some spending pressure to state-run companies. High unemployment is also a potential drag on EZA, an ETF that devotes over 34 percent of its weight to consumer discretionary stocks.

At last check, EZA was up 2.42 percent on Monday, trading at $52.42.