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Junk status: Where we’re at and what you should know

Should Moody’s change SA’s credit outlook to 'negative' next month, as anticipated, social and economic instability is likely to follow.

Johannesburg, 23 Oct 2019
Greg Morris, CEO of Sebata Group Holdings
Greg Morris, CEO of Sebata Group Holdings

In March 2019, when ratings agency Moody's kept SA's sovereign debt at above-investment grade and changed its outlook to "stable", it was the only ratings agency at the time to keep our country from dropping to "junk status". In other words, Moody's kept SA above what is considered substantial investment-grade risk.

At the time, Moody’s said: "The confirmation of SA's ratings reflects [our] view that the previous weakening of [its] institutions will gradually reverse under a more transparent and predictable policy framework. The recovery of the country's institutions will… gradually support a… recovery in its economy, along with a stabilisation of fiscal strength."

But this has not happened, and Moody’s is scheduled to review our credit rating next month. At this point, many economists predict that SA’s credit outlook will change to "negative".

This, despite the fact that Moody’s senior analyst Lucie Villa has pointed to SA’s stable economic outlook, strong institutions and reasonably good foreign currency reserves, even though serious issues continue to surround Eskom.

So, how is it looking for SA?

Despite the so-called Ramaphoria effect at the end of the tumultuous Zuma reign, when we looked forward to a more economically stable era under President Cyril Ramaphosa, there is no indication that SA will soon curb its rising debt levels.

There is also growing frustration that the ongoing factional battles in the African National Congress are hampering Ramaphosa’s ability to make the reform decisions that are needed to resuscitate our economy, including:

  • stabilising the rising debt-to-GDP ratio;
  • addressing high unemployment; 
  • tackling the low economic growth rate;
  • restructuring state-owned enterprises;
  • reducing the public sector wage bill; and
  • cutting state spending.

And what’s happening elsewhere? Well, circumstantial evidence from other countries downgraded to ‘junk status’ shows that the after-effects can hasten an economic crisis, as in Egypt in 2001, Tunisia in 2012 and Brazil in 2015.

Furthermore, significant social and economic instability is likely to follow any downgrade to junk status, and things are already volatile here at home.

What are the financial implications?

To begin with, SA would no longer be eligible to be included in debt gauges like Citigroup’s World Government Bond Index (WGBI), which could trigger a major outflow of money, an amount estimated to be R100 billion.

Welfare

In the event of a downgrade, the government has to pay more in debt-servicing costs, meaning that it has less to spend on social initiatives and infrastructure.

Taxation

To plug the funding gap, the government has to increase revenue through higher taxes. However, with corporates already taxed to the hilt, personal tax is likely to be where government will seek recovery.

Further, with the forthcoming National Health Insurance (NHI), there are indications that the public will experience one of, or a mix of, general tax revenue increases, payroll taxes and surcharges on personal income tax.

The rand

A downgrade will probably also cause the rand to depreciate, which will make imports like oil, and in turn, everything else, more expensive.

Loans

When inflation rises above a designated target range, the South African Reserve Bank increases the repo rate, which raises the cost of vehicle loans, home loans and other long-term loans. And, when lenders see a greater risk in borrowers defaulting, they increase premiums to compensate for it.

So, South Africans will find it harder to qualify for new loans, and when they do manage to access credit, it will be more expensive. This means that loans will be less of an option for individuals when their finances are stretched.

Property

When it comes to property, the ‘wait-and-see’ approach is something South African home-owners have become adept at using, paying in the interim for increases in annual council services and fluctuations in fuel prices.

Expansion

In the event of a higher interest rate environment, all other South African entities, from the large state-owned companies like Eskom to large private companies, including mining firms and banks, will have to pay more for any money they borrow. They will have less money to spend in expanding their businesses and employing more people, or they will try to put up their prices.

And is ‘junk status’ likely to be forever?

No, but it takes a long time for a country to return to investment grade.

According to Gardner Rusike, a sovereign analyst for SA at S&P Global, the firm’s ratings history shows that it can take seven to eight years to come back to investment grade. Brazil, for example, was lowered to BB+ in 2015, a sub-investment grade rating, and then again to BB in 2016. 

Stanlib chief economist Kevin Lings pointed out in 2016 that sovereign downgrades outnumbered upgrades in the preceding eight years, so there’s a trend. The average sovereign credit rating around the world has fallen by about one notch since 2008 and, since 2012, S&P Global has downgraded SA three times. But this does not mean that we should, or indeed, can afford to be, complacent about further credit ratings agency downgrades.

About the author

Greg Morris, CEO, Sebata Holdings

Greg Morris is the chief executive officer of Sebata Holdings. He joined the group in 2000 and was appointed CEO in January 2011. He is responsible for the day-to-day operations, management and corporate finance transactions of the group. He holds a Bachelor of Accounting honours degree and is a qualified chartered accountant. 

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