Just hours after Fitch changed its outlook on SA's credit rating to negative, Standard and Poor announced its downgrading by one notch.
South Africa was dealt a double blow of Friday when Fitch Ratings changed its outlook on the country’s credit rating to negative in the morning and, after markets closed, Standard & Poor’s (S&P) announced it had downgraded the credit rating by one notch.
The foreign currency rating was downgraded to BBB- with a stable outlook, while the local currency rating has been dropped from A- to BBB+.
Hours earlier, Fitch announced it has revised the outlook for the country to negative from stable and affirmed its long-term foreign and local currency ratings at BBB and BBB+, respectively.
The local currency rating relates to the country’s ability to repay debt in the local currency, while the foreign currency rating relates to the country’s ability to pay back debt in foreign currency, such as dollars or euros.
According to S&P grade definition, BBB means there is adequate currency to meet financial commitments, but is more subject to adverse economic conditions, while BBB- is considered the lowest investment grade by market participants.
The downgrade was widely expected in light of a number of challenges faced by the South African economy. In a statement, S&P cited a number of reasons for its decision.
“The downgrade reflects our expectation of lacklustre gross domestic product [GDP] in South Africa, against a backdrop of relatively high current account deficits, rising general government debt and the potential volatility and cost of external financing,” the ratings agency said.
However, it noted that the stable outlook reflects its view that current labour tensions will be resolved and that muted economic performance will not affect South Africa’s fiscal and external balance beyond the agency’s revised expectations.
Both S&P and Fitch expressed lack of confidence in the new Cabinet to accelerate much needed reforms in order to boost economic growth.
S&P said it expected 1.9% economic growth for South Africa in 2014, while Fitch too had revised its estimates down to 1.7% for the year.
Jean-Pierre du Plessis, a fixed investment strategist at Prescient Investment Management, said the ratings downgrade did not take anyone by surprise as it was widely expected that S&P in particular would need to bring their local currency rating in line with that of other agencies such as Moody’s.
The practical implication, du Plessis explained, is that it will be more difficult to attract foreign inflows into our economy, which could lead to rand weakness and even a possible reversal of foreign flow from South Africa’s bond market. But ultimately, he said, it will end with the consumer.
“Our rates are higher and therefore attractive when compared to US rates. The rating downgrade and revised outlook requires there be an additional premium to own our debt, which makes people a little bit more cautious to put their money here and it will also raise the cost of borrowing for South Africa,” he said. “That will have an impact on national treasury and our state-owned companies like Transnet and Eskom [which raise funding on the foreign bond market] and a lot of our banks will probably be moved in line with the sovereign rating. Ultimately it ends with consumer.”
Interest rate hikes
Du Plessis said the developments many also put added pressure on the Reserve Bank to hike interest rates. “The rating is still investment grade … it’s not by any means a panic situation that we are going to fall off the cliff,” said Du Plessis. “It’s just an adjustment, we would need to see a substantial further deterioration before being downgraded to sub-investment grade.”
He said that, while the foreign currency rating is more important as many countries borrow externally, “for South Africa, so much of our debt is bought by foreigners in the local bond market [that] by our peers’ standards we have very little offshore debt. It’s a good thing, because you need dollars and euros to pay that debt back.”
S&P warned it could lower the ratings if South Africa’s business and investment climate weakens further, if for instance labour disputes fester. “We could also lower the ratings if external imbalances continue to increase or funding for South Africa’s current account or fiscal deficits becomes more difficult or costly,” it said.
It said it could raise the ratings if an improvement in investment and economic growth prospects produces stronger government and external debt positions than it currently expects.