LONDON, March 31 (Reuters) - The sacking of South Africa's respected finance minister leaves the country risking a two-notch downgrade on its local currency credit rating, which would see it ejected from a key bond index and cause up to $10 billion in outflows, UBS said on Friday.
Investment outflows at that level would effectively double South Africa's current account gap, UBS said.
President Jacob Zuma's midnight ouster of finance minister Pravin Gordhan deepened a financial market selloff caused by political uncertainty that had been brewing all week.
The departure of Gordhan threatens to tip South Africa's higher profile foreign currency credit rating, currently one notch above so-called junk at BBB-/Baa2, into non-investment grade. Moody's is scheduled to review the rating next Friday.
UBS said however that a bigger danger lay in local currency debt. Rated two notches into investment grade, South Africa is one of the few emerging economies whose local currency bonds are eligible for Citi's World Government Bond Index (WGBI), a global benchmark tracked by over $3 trillion worldwide.
A two-notch cut to local ratings would exclude the country from the index, UBS noted, estimating WGBI-indexed South African bond holdings at $10 billion - just above the country's 2016 current account deficit of $9.5 billion, or 22 percent of total foreign holdings of South African debt.
WGBI membership hinges on investment grade ratings on local debt from both Moody's and Standard & Poor's.
"South Africa's continued inclusion in WGBI rests on a local currency investment grading rating from S&P and Moody's – presently two notches away," UBS analysts told clients.
"Any unwind of these positions could effectively double the expected current account deficit."
Fitch said on Friday that the cabinet shake-up heightened political risk and signalled policy change, and could result in a review of its ratings on South Africa. (Reporting by Sujata Rao; editing by Richard Lough)