Pay off your debts and cut your costs


It is not pretty and it could get downright ugly. The downgrade this week by ratings agency S&P Global, with the expectation that others will follow, is going to hit South African consumers in their pockets, according to economists and analysts.

But there are slim silver linings to the clouds of the Cabinet reshuffle for individuals saving for their retirement.

The overwhelming message from experts is not to panic in the current turmoil, pay off debt while you can and cut costs, however small they may be.

On Monday evening, S&P announced it had lowered South Africa’s foreign currency credit rating to subinvestment grade, or “junk”, and its local currency rating to one notch above junk status.

Moody’s announced it has placed South Africa on review for a downgrade, hours after S&P announced its decision.

The foreign currency credit rating applies to the debt a country issues in a foreign currency. In other words, it is the agency’s view of the ability of an issuing country to meet its loan obligations in a foreign currency.

The local currency rating applies to debt issued in a country’s own currency.

South Africa has about R2.2-trillion in government debt, with about 10%, or R220-billion in foreign currency, such as the US dollar and the euro, according to the treasury.
The rest is denominated in rands.

It is the local currency ratings by two ratings agencies that determine whether South Africa will remain included in key global bond indices such as the Citigroup world government bond index (WGBI).

Should ratings agencies Moody’s and Fitch follow S&P’s lead, as many fear will happen, it will begin to hurt people’s pockets, particularly if the rand continues to weaken and interest rates begin to rise.

“The downgrade means South Africans are going to be poorer,” said Steven Nathan, the chief executive of 10X Investments.

The cost of borrowing will rise significantly for everybody, he said, and the government will have less to spend on services such as housing, education and health.

The effect on the currency has already begun to be felt, said Dave Mohr, the chief investment strategist of Old Mutual Multi-Managers.

The rand had moments when it fell to lows of more than R13.90 to the dollar after the downgrade, before it stabilised somewhat.

A weaker currency increases the chances that inflation will rise, Mohr said, and an immediate and direct effect of this is likely to be an increase in the petrol price.

But a hit on the currency could be short term, because a downgrade is not the only thing that affects its performance, Mohr said.

Over time, there are many other factors that affect the rand and a ratings change on its own will not forever dominate how the currency performs.

Nevertheless, the South African Reserve Bank is likely to be more cautious when it makes decisions on interest rates.

Confidence was developing over the possibility of an interest rate cut towards the end of the year, but this is now likely to be postponed.

If the other ratings agencies follow S&P’s lead and downgrade South Africa, interest rates are likely to rise, according to Chris Gilmour, an investment analyst at Absa Wealth & Investment Management. This will increase the cost of servicing debt on expenses such as home loans and car repayments by 2% to 3% over time.

The rand may lose further ground against international currencies, increasing the prices of imported foreign goods, Gilmour said.

According to the treasury, a downgrade to junk status and a 3% increase in interest rates could increase monthly expenses for a household by almost R3 000. These estimates are based on assumptions that include a household holding a mortgage bond of R1-million, outstanding credit card debt of R20 000 and a R400 000 vehicle loan.

Repayment on a R1-million mortgage at the prime interest rate of 10.5% is estimated at R9 984 a month. This would rise to R12 074 if the interest rate rose to 13.5%, while vehicle repayments would rise from R8 598 a month to R9 204.

Mohr said it is too early to say that interest rates will rise, particularly if the currency stabilises and does not drop below R14 to the dollar. At current levels, the exchange rate is not much worse than it was at the start of the year and is much better than a year ago, he said.

The most significant effect of the downgrade could be the knock on business and consumer confidence.

“It will typically make businesses hesitant to invest and to expand their operations and hire more people,” Mohr said.

As confidence in South Africa declines, many business might decide to expand internationally, to diversify their sources of income and to reduce their vulnerability to the local economy.

The gloominess notwithstanding, Mohr said, people should “not panic and start to cash in their investments”.

A typical pension or retirement fund is able to allocate 25% of its investments offshore. In addition, he said,  the JSE has “internationalised enormously” – with more than half the revenue of companies listed on the JSE generated outside South Africa.

The typical pension fund will also ordinarily have somewhere between 40% and 55% invested in South African equities, besides its 25% offshore allocation.

As such, more than half the assets of a typical retirement fund are in effect externalised.

Although the JSE is likely to come under some pressure because of the current uncertainty, over time its fundamentals will come through, Mohr said.

The lesson to be learnt from the Cabinet reshuffle is that no one can predict these kinds of events, said Nathan, and investors should not try to.

“Focus on long-term goals rather than on short-term uncertainty in financial markets,” he said.

Economic growth and, consequently, investment returns are likely to be lower but these are out of an individual investor’s control, Nathan said.

Instead, investors should try to manage the things they can control, such as costs.

“You can’t manage returns but you can save on costs, even if it’s as little as 1%,” he said. “It seems like nothing but over 10 years a 1% saving means you are going to get 10% more money,” he said.

Gilmour did warn that, should interest rates increase, it is unlikely there will be proportionally linked wage increases, making it difficult for consumers to repay their debt, particularly those who are already overindebted.

“If you’re heavily in debt at this point in time, best you get your indebtedness down significantly. And, if you find yourself struggling to cope with your financial commitments, speak to your bank early on to see what plans can be put in place to assist,” Gilmour said.

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