A downgrade to junk status will hurt everyone
The question is: Can those in government work together to claw back an investor-friendly status for South Africa?
“It’s zero good and all bad.” This is how one economics professor sums up what it means for the average person should South Africa’s debt be downgraded to subinvestment grade or “junk” status.
Jannie Rossouw, the head of the school of economic and business sciences at the University of the Witwatersrand, was a senior official at the Reserve Bank for many years, including those when South Africa, a fledgling democracy, clawed its way out of junk status to become investment grade.
Now the country, after sliding consistently in the rankings of all three major ratings agencies, Standard & Poor’s (S&P), Fitch and Moody’s, is teetering on the brink of junk status.
S&P and Fitch have South Africa pegged at BBB–, one notch above subinvestment grade. Moody’s has the country pegged at two notches above subinvestment grade but has placed South Africa on review for a downgrade. Its team arrives this week to begin the review.
“You don’t restore your credit-worthiness in 48 hours,” Rossouw said. “Once you have thrown it away, it takes a long time to restore.”
It was sound economic policy, including the reduction of the budget deficit and the right statements from the government, that saw ratings agencies upgrade South Africa’s debt, he said. At the time, the country was also the flavour of the month.
“The world loved us to pieces. We had Nelson Mandela. South Africa could do no wrong.”
Now it seems the country can do no right, he said, and this means more discomfort for South Africans.
Credit ratings assess the riskiness of buying South African debt – the higher the risk, the higher the premium, Rossouw said. That premium is expressed in the higher the interest the country must pay when it borrows from investors.
“Generally the government will pay more for debt than what it paid before,” he said.
And, because it will be less attractive to invest in South Africa, the rand is likely to depreciate. Imported goods – including items such as oil and, most notably, food that the country has to import because of the drought – will become more expensive, which will push up inflation. When inflation increases, Rossouw said, the South African Reserve Bank will have to put up local interest rates.
Consumers will have to pay more for the items they need every month, and the interest they pay on their home and car loans will increase.
“The result will be a higher interest rate environment,” said Rossouw.
Added to this, if the government’s borrowing rate (known as the sovereign rate) increases, all other South African entities, from the large state-owned companies such as Eskom to large private companies such as mining firms and banks, will have to pay more for any money they borrow.
They will have less money to spend in expanding their businesses and employing more people or they will try to put up their prices, he said.
The threat of a downgrade looms at a time when South Africa is facing long-standing structural issues – such as electricity shortages – which have affected local economic growth at a time when global economic growth is slow.
Matters are not helped by the deep uncertainty caused by the politics engulfing the treasury, sparked when former finance minister Nhlanhla Nene was removed in December, eventually to be replaced by Pravin Gordhan. Tensions have spiralled into a now open battle between Gordhan and the South African Revenue Service commissioner Tom Moyane, and a stand-off between Gordhan and the Directorate for Priority Crime Investigation (the Hawks).
These political clouds notwithstanding, Gordhan, as well as business and labour leaders, is not waiting for the ratings axe to fall.
On Monday, he held a briefing on the international road show he led last week, following the 2016 budget, to inform investors about local economic developments. Investors own about R600-billion of debt issued by the government and South African companies, according to him.
Avoiding a downgrade is important, if only because it takes a long time to return to investment grade. According to Gardner Rusike, a sovereign analyst for South Africa at S&P, the firm’s ratings history shows that it takes seven to eight years to come back to investment grade, with little evidence of any country “bucking the trend”.
“Normally when countries are downgraded to noninvestment grade, there are usually more downside risks,” he said.
He gave the example of Brazil, which was lowered to BB+ in 2015, a subinvestment grade rating, and then again to BB in 2016.
“So it may take longer coming back up as addressing the key drivers to downgrade may be slower in the different sovereigns [countries],” he said.
Besides concerns over the political environment and slow economic growth, investors want clarity on the risks that state-owned entities place on the fiscus, issues relating to business and investment confidence, and clarity over regulatory, labour and monetary policy.
“As South Africans, we need to be very aware that we need to provide very concrete evidence over the next few months that we are not just talking … It is time for collective action, concrete action and demonstrable action,” said Gordhan.
Cas Coovadia, the managing director of the Banking Association South Africa, said concrete measures to address the issues raised include work by business to look at the industries “on their backs at the moment”, such as mining, construction and agriculture. This will include finding solid investment projects that will help them to recover. Another element is to identify sectors with high growth potential that have not been fully exploited, such as tourism and export-led manufacturing, and determining what sort of investments these sectors need.
In the next three months, concrete plans and timeframes to implement them will be put on the table, Coovadia said.
In a letter to the Sunday Times, written by Coovadia, Goldman Sachs’s managing director Colin Coleman and Shoprite chairperson Christo Wiese, business has suggested some specific objectives aimed at preventing a downgrade.
These include not just fixing legislative impediments to investment, including improving and finalising amendments to the Mineral and Petroleum Resources Development Act, but also addressing legislation causing uncertainty over “the protection of property”.
Most recently, the Expropriation Bill – which is now before the National Council of Provinces – has been criticised for undermining property rights.
Included in the proposals on labour reform is the need to agree on inflation-linked wage increases and an emphasis on performance-linked bonuses.
The private sector and the ANC government and its alliance partners have clashed over these issues in various forums in the past, and it remains to be seen whether the pressure faced by the country can force agreement on these issues.
Telkom chairperson Jabu Mabuza has told reporters that, “notwithstanding our various differences … [between business, labour and government] understand that there will be pain [but] there will be more pain if we get downgraded”.
“There will be trade-offs that need to be made by all of us,” he said.
Nazmeera Moola, an economist at Investec Asset Management, said South Africa’s journey to an investment grade rating in the late 1990s was accompanied by significant fiscal consolidation.
It also took “very clear agreement across government” about what it wanted to achieve, under the leadership of both presidents Nelson Mandela and Thabo Mbeki, working together with then finance minister Trevor Manuel.
“That is what we need; we need certainty in policy,” she said. “It is just not clear that the current political economy presents this opportunity.”
SA is not alone, but its performance sucks
Although South Africa is facing further credit ratings downgrades, Finance Minister Pravin Gordhan told reporters this week that “we are not the worst off in the world. There are many countries in a worse-off position than ourselves,”
Peer countries such as Brazil and Russia have had their credit ratings downgraded to below investment grade, and South Africa is battling to retain its investment status against a backdrop of more adverse credit ratings globally.
In a research note, Stanlib chief economist Kevin Lings said sovereign downgrades have outnumbered upgrades in the past eight years, according to data from ratings agency Standard & Poor’s. The average sovereign credit rating around the world has fallen by about one notch since 2008, he said, although, since 2012, S&P has downgraded South Africa twice.
South Africa, rated at BBB–, is within the average international credit rating of between BBB and BBB–, Lings said. Twenty-five countries besides South Africa have a negative ratings outlook, and only eight have a positive outlook, suggesting that sovereign credit ratings are likely to decline even further in 2016.
Slightly more than half of all rated countries are investment grade, the lowest level it has ever been, he said.
This appears to be because of S&P rating previously unrated countries and because of the poor economic performance of many countries, including the likes of Brazil and Russia.
“It is clear that the ratings downgrade South Africa has experienced in recent years is not exceptional when compared with the global trend,” said Lings, adding that downgrades have been particularly evident among commodity exporters.
But it does not mean that South Africa should be complacent about further downgrades. A move to below investment grade will make South Africa one of the worst-performing countries since 2008 and it is critical that “policy officials do all they can to help South Africa avoid any further downgrades”, he said. – Lynley Donnelly