Deep Read: A dummy's guide to SA's credit downgrade
16 Oct 2012 13:47 | Nickolaus Bauer
So why was South Africa downgraded?
Industrial action in the mining sector has caused a knock-on effect. Investors are now more wary of increasing their financial concerns in South Africa and our currency has taken a severe knock, falling to a three-year low against the US dollar.
The truck drivers’ strike ended after nearly three weeks and the damage done in the form of food and fuel shortages sent shudders through our already ailing economy.
With more industrial action on the cards – this time by the municipal workers – the unheaval seems far from over.
Jobs are being shed, employment opportunities are disappearing, and growth forecasts are declining. In essence: South Africa is not looking as good an economic bet as it was a couple of years ago, or even a few short months ago.
Why should I care?
This is important because our country’s economy was already in a tight spot due to the financial crisis in Europe, our largest trading partner, which translated into a weakened demand for our goods to that region.
A high score from a credit rating agency means cheaper borrowing costs when you need a loan, while a low mark carries the heavy price of inflated interest rates and other charges as you are seen to be more of a credit risk.
This is the difference between asking the bank for a loan with a house fully paid off, as opposed to asking for more money when you’re indebted to the gills and it does not seem as though you are capable of paying it off.
But it’s not like we missed an instalment, so how does it work?
In simplistic terms, credit ratings are a marking system designed to inform interested parties of the risk in the debt of a country or a large company.
Scores are given to large-scale borrowers and tell the parties prospectively dishing out the funds to these debtors how likely it will be that they’ll get their money back.
For example, a AAA-rating is the best credit rating that can be given to a borrower, which shows the risk of them missing a payment or defaulting is minuscule.
This goes down to the other end of the spectrum where we have scores like BB or Ba1 down to C which are termed as speculative - or "junk". This means the lender has no real idea of the likelihood of getting their debt back.
Credit ratings for countries and companies work more or less the same way as it does for private individuals looking for anything from a homeloan to a credit card or cellphone contract.
Think of two individuals who apply for a credit card with a limit of R10 000.
Mxolisi is a business executive who owns two houses with a small amount left on the mortgage for both properties. He earns R30 000 a month and is married but has no children as dependents.
Alan, on the other hand, is a workshop foreman who rents the house he, his wife and three children stay in. He only earns R15 ;000 a month and is already R5 000 in debt after taking a personal loan two years back, which he has as of yet not paid back.
Good financial sense dictates that Mxolisi is more deserving of a credit card with a R10 000 credit card and is more likely to have his application approved than Alan is.
Those who lend money will always be particular about who they lend money to – even more so in tough economic times.
But credit ratings are not always dictated by the amount of debt an individual, company or country is in already, but rather by the ability to repay the loan.
This is why the United States, who is in a lot more debt than South Africa, will be granted more money due to their AAA credit rating.
They may be liable to pay more debt than we are, but based on their assets, liabilities and their ability to repay their debt dictates they are a better bet than South Africa.
Conversely, Greece’s credit rating is lower than South Africa’s because in spite of a higher GDP per capita, their inability to repay their debt translates into a worse score than ours.
But who are these credit rating guys anyways?
There are hundreds, if not thousands of credit rating agencies around the world. But the so called “big three” credit rating agencies that send investors scurrying for cover if they merely breathe the wrong way are Standard & Poor's, Moody's Investor Service, and Fitch Ratings.
Moody's and S&P each control about 40% of the market, while third-ranked Fitch has about a 14% market share and is often used as an alternative to one of the other majors.
Their intentions and reliability are sometimes questioned based on their financial interests and an over reliance on what they say.
A common criticism, which is consistently related to the massive bank meltdown that led to the 2008 financial crisis, is the dominance the agencies have on the market.
At that point in time these three agencies held 95% of the market share and there was virtually no room for competition.
There were some economists who thought the big three held back negative information about the financial environment at the time, in the hopes the problems would simply fade away. Conspiracy theorists will go even further to suggest the big three withheld information in the hopes of protecting their revenue stream from banks that were in financial trouble.
But the problems didn’t disappear and the world experienced the worst financial crisis since the late 1920s depression.
Since 2008, there has been a marked push to spread the playing field and have a plurality of voices pronouncing on the world’s financial health in the hope that this will diminish conflicts of interest and create more transparency in ratings.
So I should take what these agencies say with a pinch of salt?
If only it were that easy. Unfortunately the vast majority of wealthy individuals, investors, companies and countries will quote what S&P, Moody’s or Fitch say as if it were straight from the Bible, Qur'an or Torrah.
Once they’ve pronounced on your supposed credit health – or sickness, as is South Africa’s case – expect immediate repercussions.
Additionally, if you’ve received a bad report from one of the big three it’s likely the other two will follow suit.
Effectively: Money talks – bullshit walks.
What can I do to help?
There is nothing you as an individual can do to affect South Africa’s credit ratings. Unless you are one of the several analysts tasked with formulating our credit rating and are prepared to cook the books, your hands are tied.
So I can’t do anything?
Well, not exactly.
As a citizen of the republic you can find out who your elected MP or ward councillor is for your area and address your concerns with them and request they take the matter to a higher level of government.
If they don’t listen to you the first time you could always gain strength in numbers and form a petition, or have several other like-minded individuals also approach their elected officials from their respective areas.
If your anxieties are eventually entertained, the matter could be taken to Parliament and put on the agenda to be discussed by members.
If a consensus is reached that the problem is so drastic that action needs to be taken, it could push government to change its economic strategy.
This change would hopefully appease the mighty big three, which would then expectantly lead them to improve our credit rating.
But all of this would involve a lot more effort than simply moaning, threatening to emigrate or toyi-toying and striking.
You decide if the juice is worth the squeeze.
View the original online publication here