/ 26 February 2020

Moody’s axe likely to fall on ordinary South Africans

A Ba3 rating was awarded to Nigeria and a B1 rating was given to both Zambia and Kenya.
The country’s rising debt risk is also putting added pressure on ratings agency Moody’s Investor Service to downgrade South Africa’s sovereign credit rating to junk.

It has been a bumpy start to 2020 for the South African economy. Within the first few months, the International Monetary Fund (IMF) slashed the country’s growth forecast for 2020 and 2021 to 0,8% and 1,0% respectively. 

The country’s rising debt risk is also putting added pressure on ratings agency Moody’s Investor Service to downgrade South Africa’s sovereign credit rating to junk. 

In November, Moody’s changed the country’s outlook from stable to negative and put South Africa on notice of a downgrade. At the time, the ratings agency said the change in outlook reflects the risk that the government would not be able to grow the economy and cut its debt. 

Moody’s also warned that the government will find it difficult to drum up the necessary political support to improve economic growth. 

Credit ratings are a measure of the creditworthiness of the government’s ability to pay back borrowed money. The ratings are important because they influence the cost of borrowing for a country. If a country is likely to default then creditors will charge higher interest rates. 

Earlier this month, the ratings agency cut its 2020 economic growth forecast for the country from 1% to 0,7%. It cited South Africa’s lacklustre domestic demand, adding that the widespread power outages implemented by Eskom are detrimental to manufacturing and mining, which are crucial to the growth of the country’s economy.

The ratings agency is the last of the the three major ratings agencies — the other two being Standard and Poor’s and Fitch — to still hold the country’s debt at investment grade. The market has predicted that  come March, Moody’s would move the country’s rating to junk, amidst rising public debt levels, weak economic growth and lower than expected tax collection.

“Those that dismiss the importance of ratings agencies often do not understand the economic realities of the global capital markets, from which South Africa has to borrow to keep the economy and government services running,” says managing director of the Banking Association of South Africa, Cas Coovadia. 

If the country’s credit rating is downgraded to junk, then the credit ratings of all the country’s banks will also be downgraded, says Coovadia. 

“A poor credit rating increases the cost of funding for banks which in turn increases borrowing costs for businesses, consumers and government. All South Africans who borrow money will have to pay more in interest to compensate for the greater risk premium to which lenders are exposed.”

“The increased cost of funding also reduces banks’ ability to lend to small businesses and extend credit for entrepreneurship and personal development,” he says. 

While a downgrade may already have been somewhat priced into the South African markets, a formal announcement threatens the economy with a weaker rand and a higher inflation rate, says Citadel’s Chief Economist Maarten Ackerman. 

“Government will have less money to spend on crucial social services and it will likely create an even tighter environment for balancing the budget than what we have now,” Ackerman says. 

While S&P and Fitch both downgraded South Africa’s credit to junk almost two years ago, Moody’s “has been kicking the can down the road for a long time,” says Ackerman. He adds that while the government has been able to keep the Moody’s axe at bay for a while now, it might not be that way in 2020. 

“The market has already priced in a downgrade because  some of our bonds are trading as if we are downgraded already. If Moody’s can see that there is any chance of turning the fiscal trajectory around they might just give us a little bit more time, otherwise they will be left with an egg on their face because the numbers already suggest that we should have been downgraded already,” Ackerman adds. 

Political Economy Southern Africa’s economist and executive director Siya Biniza says that it is unlikely that Moody’s would announce a downgrade of the country credit come March 27. Instead, he says that the ratings agency would probably still be willing to assess whether or not the South Africa government will implement the structural reforms that are needed to turn the country’s economy around. 

He adds that, since the Fitch and S&P downgrades, the country’s economy has worsened and the situation at Eskom has not improved. “In spite of this, the government is still servicing its debt and the country is nowhere near the situation in Zambia, where the government is facing a liquidity crisis because of downgrades.”

“Theoretically it is not too late — Moody’s has not yet made its decision,” says PwC Economist, Christie Viljoen.

“In reality, the reforms needed on the expenditure side of the budget – specifically to the wage bill and funding of SOEs — cannot be implemented by the finance minister due to political reasons.”

Viljoen says that Moody’s may wait until the medium term policy statement in October before announcing its decision. This might be positive, if the government can convince the agency that the country’s fiscal situation will improve over the coming months.  

“The actual act of downgrading is not a major issue, given that financial markets have already priced in the downgrade. This implies that government borrowing is already more expensive and investment in the country appears less attractive.”

What the downgrade would do would be to create volatility for the Rand, and for bond rates. This would affect the cost of exports and imports, as well as make government borrowing more expensive. But Viljoen says this “will not divert the long-term trend” and the economy would still grow.