Ratings warning a red flag

Global ratings agencies, having erred on the side of allowing the GIIPS countries (Greece, Italy, Ireland, Portugal and Spain) to raise capital at a low cost on the back of the AAA ratings of other European Union members, have become cautious.

Europe’s sovereign debt crisis was founded on excessive government expenditure fuelled by borrowing costs that were originally too low to adequately reflect the associated risk with regard to repayment, resulting in the unsustainable ballooning of borrowings.

The rating agencies have rapidly downgraded many euro members since, sending the cost yields higher, in tandem with increasing news flow on the poor health of the respective governments’ finances. Although a country’s credit rating is merely the rating agency’s (forward-looking) view of the sovereign’s ability and willingness to repay its debts on time and in full, the high regard in which they are held means they have severe implications for all countries, particularly when altered.

The higher a country’s credit rating, the cheaper its cost of borrowing. An AAA rating is the most desirable. If a country’s credit rating is lowered, its interest rates are likely to rise, harming economic growth and hindering businesses in raising capital. South Africa’s rating on its long-term debt has steadily been upgraded, from a BB (not investment grade) in 1994 by Standard & Poor’s and Fitch to BBB+ (two notches above the lowest investment grade) in 2005 as the country showed improved economic growth and employment creation and a reduction in the fiscal deficit from 7.3% of gross domestic product to essentially a balanced budget (no deficit) during that period.

This hard-won improvement in government finances should not be underestimated, particularly because it came at the cost of a deficit in infrastructure investment. Not only did Eskom pay its sizeable profits to its only shareholder (the government) during this period, the government itself also cut back substantially on capital investment, as did many public corporations.

Insufficient expenditure on fixed investment does not become apparent immediately, which is why South Africa has only recently found itself in the predicament of crumbling infrastructure. The user-pays principle does, and will, garner sizeable funds for the institutions, but at significant cost to the South African population.

South Africa still holds an investment grade rating of BBB+ from Fitch and Standard & Poor’s, and an A3 from Moody’s. The ratings are underpinned by its low debt levels and the depth of its capital markets, central bank independence, the soundness of its financial sector, political stability and the transparency of its institutions. But the high unemployment rate, high level of poverty, sizeable social development needs and attendant growth in the funding needs of the government are not only preventing South Africa from gaining a higher credit rating, according to the agencies, but also placing it at the risk of a downgrade.

Rating agencies are worried about the deterioration in the good health of South Africa’s public finances because of pressure from both the ruling party and the population for increased social expenditure, despite deteriorating revenue collection as a result of weak economic growth. Moody’s believes there is now heightened political risk.

Although South Africa has not received an actual downgrade to its credit rating, Fitch has joined Moody’s in placing the country on credit watch (downgrading the rating outlook to negative). The move is partly owed to the heightened sensitivity to sovereign ratings globally, as well as the increased political noise domestically in the build-up to elections, as focus on service delivery and the upliftment of the poor is intensified. South Africa’s government finances are in an admirable state, both historically and comparatively, and a ratings downgrade is neither justified nor was it delivered.

However, the change to a country’s rating outlook is a necessary precursor to a downgrade of its actual sovereign credit rating. As Moody’s rates South Africa one notch higher (A3 or A-) than Fitch and Standard & Poor’s (BBB+), a Moody’s downgrade would merely mean the agencies are aligned. But a downgrade from Fitch would be a lot more serious because South Africa would fall to BBB, pushing borrowing costs (interest rates) higher.

This would exacerbate the already significant rise in South Africa’s borrowing costs that is occurring on the back of the steady expansion of government debt. A downgrade to BBB would have additional severe implications. No company can have a higher downgrade than the country in which it is domiciled. South Africa’s banks and other large corporates, rated BBB+ by Fitch, would simultaneously experience rating downgrades on a sovereign downgrade and so raise borrowing costs.

The warning must be taken seriously. South Africa’s government finances must not be squandered by rising debt levels used to fund current expenditure (social welfare and increases in public-servant remuneration instead of fixed investment).

Annabel Bishop is a group economist at Investec

PW Botha wagged his finger and banned us in 1988 but we stood firm. We built a reputation for fearless journalism, then, and now. Through these last 35 years, the Mail & Guardian has always been on the right side of history.

These days, we are on the trail of the merry band of corporates and politicians robbing South Africa of its own potential.

To help us ensure another 35 future years of fiercely independent journalism, please subscribe.

Advertisting

Western Cape Judge Mushtak Parker faces second misconduct complaint

The Cape Bar Council says his conduct is ‘unbecoming the holding of judicial office’

‘My biggest fear was getting the virus and dying in...

South African Wuhan evacuee speaks about his nine-week ordeal

Border walls don’t stop viruses, but a blanket amnesty might

Why South Africa should consider amnesty for undocumented migrants in the time of the coronavirus outbreak.

Press Releases

The online value of executive education in a Covid-19 world

Executive education courses further develop the skills of leaders in the workplace

Sisa Ntshona urges everyone to stay home, and consider travelling later

Sisa Ntshona has urged everyone to limit their movements in line with government’s request

SAB Zenzele’s special AGM postponed until further notice

An arrangement has been announced for shareholders and retailers to receive a 77.5% cash payout

20th Edition of the National Teaching Awards

Teachers are seldom recognised but they are indispensable to the country's education system

Awards affirm the vital work that teachers do

Government is committed to empowering South Africa’s teachers with skills, knowledge and techniques for a changing world

SAB Zenzele special AGM rescheduled to March 25 2020

New voting arrangements are being made to safeguard the health of shareholders

Dimension Data launches Saturday School in PE

The Gauteng Saturday School has produced a number of success stories