How to deal with a downgrade

The South African economy was dealt something of a body blow at the end of last week when leading ratings agency Fitch downgraded our outlook from stable to negative, citing continuing unemployment, which it said was putting pressure on growth and narrowing the tax base.

“The negative outlook reflects the limited progress on several long-standing structural issues that have, over time, caused South Africa’s economic performance to fall behind its peers,” said Fitch’s Purvi Harlalka.

“Not least of the problems that require urgent attention is the economy’s inability to create sufficient jobs. This inability has not only constrained growth and kept the tax base narrow but has also caused public finances to become increasingly redistributive in an effort to address the lack of social mobility.”

The JSE responded by roaring to an all-time record on Tuesday, topping 33 489 and eclipsing the previous record of 33 334 set in February last year.

How do we understand this? Are ratings downgrades good for investment sentiment and, as such, should we try to get more, or have markets been so spooked for so long that they are behaving irrationally?

One leading player, Bill Gross of Pimco, has reached for the paranormal to explain market behaviour. His views are taken seriously as his company is one of the largest bond traders globally and he is a frequent guest on business television channels and an op-ed contributor to titles such as the Financial Times.

Although Pimco previously characterised the “new normal” as low growth, high unemployment and continued deleveraging (when investors continue to reduce their exposure to debt), Gross argues in a January newsletter that continuing deleveraging coupled with cheap central-bank money will create deflation and hyperinflation at the same time. “It’s as if the Earth now has two moons instead of one and both are growing in size like a cancerous tumour that may threaten the financial tides, oceans and economic life as we have known it for the past half-century,” he writes. “The financial markets are slowly imploding because there’s too much paper and too little trust.”

This is big stuff. How do you invest in a paranormal environment? Do you listen to what a ratings agency is telling you or do you respond to the actual performance of the market?

Mervyn King, the respected governor of the Bank of England, believes too much credence is given to the ratings agencies. He said this week that it was better to judge sovereign risk based on the yields government bonds attracted rather than what the ratings agencies thought. Noting that the market had given a muted response to France’s loss of one of the As in its AAA rating, King said: “We need to move to a point, and I think markets have gone some way towards that, where they pay less attention to the verdicts of the ratings agencies.”

King thinks the markets are rational; Gross sees them as paranormal.

Standard & Poor’s cut France’s ratings by one notch, citing the European leaders’ inability to come up with a plan to tackle the eurozone debt crisis. Nine countries overall had their ratings cut.

The South African treasury responded to the country’s Fitch down­grade by saying that it remained committed to the prudent execution of employment generating growth. It said it viewed the downgrade in the context of “the challenges the global economy is going through and the persistent uncertainty in the global economic environment”.

The treasury would probably like Gross’s paranormal allusion that uncertainty is the new certainty. But Gross’s critics say he has ample reason to feel disturbed, given his atrocious performance as the manager of one of Pimco’s funds, which underperformed its benchmark by 4.05%.

“This degree of underperformance can get you fired in the equity universe and is almost unheard of in the bond universe,” said Investing Daily.

“Yikes,” it said, “are these frightening fulminations the workings of a bitter fund manager trying to blame his recent underperformance on para-normal forces beyond his control, or are they brilliant insights from an experienced and highly successful bond investor? Probably a little of both.”

How should South Africa respond? Do we say the ratings agencies are out of touch, as King says, that the markets are paranormal as Gross says, or blame the eurozone, which is apparently what the treasury wants to do?

We don’t have to look too hard to find an answer. French President Nicholas Sarkozy awoke in recent days to one of the country’s leading newspapers reporting the downgrade in a headline that read “S rkozy”, with the “a” having fallen into the body of the text.

But Sarkozy did not look to the occult or third parties for a solution. He immediately began a dialogue with organised labour on how best to restore the AAA rating, his key options being labour-market reform or more austerity.

Subscribe to the M&G for R2 a month

These are unprecedented times, and the role of media to tell and record the story of South Africa as it develops is more important than ever.

The Mail & Guardian is a proud news publisher with roots stretching back 35 years, and we’ve survived right from day one thanks to the support of readers who value fiercely independent journalism that is beholden to no-one. To help us continue for another 35 future years with the same proud values, please consider taking out a subscription.

And for this weekend only, you can become a subscriber by paying just R2 a month for your first three months.

Kevin Davie

Kevin Davie is M&G's business editor. A journalist for more than 30 years, he has worked in senior positions at most major titles in the country. Davie is a Nieman Fellow (1995-1996) and cyberspace innovator, having co-founded SA's first online-only news portal, Woza, and the first online stockbroking operation. He is a lecturer at Wits Journalism. In his spare time he can be found riding a bicycle, usually somewhere remote.

Related stories

No money to spare as GDP set to fall

With little money to respond to Covid-19, the government is looking at other sources of funding

Moody’s could hold decision on SA downgrade — for now

The ratings agency is expected to say on Friday whether it will downgrade SA’s credit rating to junk, but it could hold off until the Covid-19 pandemic eases

Moody’s axe likely to fall on ordinary South Africans

The ratings agency is scheduled to announce its decision on a possible downgrade of SA credit worthiness on March 27

Move to renewables already here

The electricity crisis has spurred the government on to use independent power producers to boost the grid

Cosatu suggests an Eskom solution

The union federation offers unprecedented concessions on job protections

Whatever happened to Ramaphoria?

“Overall it seems not only is Ramaphoria dead [it was never alive] but the long arc of reform potential is being lost in the discourse."

Subscribers only

ANC: ‘We’re operating under conditions of anarchy’

In its latest policy documents, the ANC is self-critical and wants ‘consequence management’, yet it’s letting its members off the hook again

Q&A Sessions: ‘I think I was born way before my...

The chief executive of the Estate Agency Affairs Board and the deputy chair of the SABC board, shares her take on retrenchments at the public broadcaster and reveals why she hates horror movies

More top stories

Exclusive: Top-secret testimonies implicate Rwanda’s president in war crimes

Explosive witness testimony from the International Criminal Tribunal for Rwanda implicates Paul Kagame and the RPF in mass killings before, during and after the 1994 genocide.

Shadow of eviction looms over farm dwellers

In part two of a series on the lives of farm dwellers, Tshepiso Mabula ka Ndongeni finds a community haunted by the scourge of eviction

Editorial: Crocodile tears from the coalface

Pumping limited resources into a project that is predominantly meant to extend dirty coal energy in South Africa is not what local communities and the climate needs.

Klipgat residents left high and dry

Flushing toilets were installed in backyards in the North West, but they can’t be used because the sewage has nowhere to go

press releases

Loading latest Press Releases…