* Dollar bond oversubscribed as investors ignore challenges
* Rand cheered by investor interest
* Downgrades to junk still looming (Recasts lead with successful foreign bond issuance)
By Mfuneko Toyana
JOHANNESBURG, Sept 30 (Reuters) - South Africa issued a pair of new dollar bonds worth $3 billion on Friday in a surprise show of confidence by investors in an economy that narrowly avoided recession and faces possible downgrades to junk in coming months.
The rand erased losses after the issuance was announced, and was 0.86 percent firmer against the dollar at 13.7600 by 1440 GMT, lapping up the positive sentiment as yield-hungry investors ignored the country's dismal growth prospects.
"There have been a lot of ratings downgrades across the globe this year, which really helps those countries which maintain their investment grade ratings," said managing director of ETM Analytics George Glynos.
"So South Africa is still benefiting from the fact that it has an investment grade rating."
Fitch and SP Global Ratings both score the country's debt at BBB-, the lowest rung on the investment ladder, with a negative outlook. The next round of reviews are due in December.
On Thursday a Standard & Poor's executive warned that slow reform of state-owned firms and the upheaval swirling around the finance minister, along with low growth, posed a risk to the country's investment grade status.
Deputy Governor of the Reserve Bank Daniel Mminele echoed those concerns at a financial conference on Friday, saying that the current growth rates were "woefully inadequate" and that the country needed to stabilise policies to reassure investors.
While the economy managed to grow 3.3 percent in the second quarter after a 1.2 percent contraction in the first, analysts warn growth will remain around 1 percent in the medium term, stifled by falling global demand for commodities and weak production at home.
The central bank estimates Africa's most industrialised economy will grow only 0.4 percent in 2016.
Investors have also been rattled by a probe into Finance Minister Pravin Gordhan by an elite police unit investigating his role in establishing a spy unit in the revenue service.
Opposition parties and civil society have described the probe as a "witch-hunt" by factions allied to President Jacob Zuma. The president denies that there is a rift between him and the finance minister.
Nineteen of 23 economists surveyed by Reuters in August said that the investigation of the finance minister posed a "significant" risk of triggering a downgrade.
The country also faces high unemployment, poverty and student unrest, while infighting in the ruling African National Congress and accusations of government corruption are seen hobbling much-needed economic reforms. (Additional reporting by Ed Stoddard; Editing by Dominic Evans)