SA is hovering on “junk status” threshold.

OWN CORRESPONDENT

Dr Adrian Saville

Chief Strategist of Citadel Asset Management and Non-Executive Director

What do you think the chances of a ratings downgrade are for South Africa?

There is a very good chance that at least one of the major ratings agencies will downgrade South Africa to sub-investment grade through the course of 2016. However, there are a number of technicalities that sit around this decision that mean that South Africa can be labelled “junk” or, perhaps less emotively, “high yield”, but that will still prevent it being pushed out of the World Government Bond Index (WGBI).  

It is ejection from the WGBI that represents the most dramatic outcome under a ratings downgrade. For this reason the issue to focus on is less “what one agency holds” than “whether South Africa stays in the WGBI”. 

For South Africa to be ejected from WGBI would require our rating on rand-denominated debt to be classified sub-investment grade and it would require Moody’s and Standard & Poor to make this assessment.  

Currently we are at least two steps away from this when it comes to rand-denominated debt, whereas media attention has focused on the ratings agencies’ views on foreign currency-denominated debt, which indeed is one step away from “junk”, in the case of S&P.  

Regardless of the technicalities, if you consider the macroeconomic variables that matter, such as economic growth, government debt, the current account deficit and budget deficit, it is hard to escape the conclusion that South Africa ranks at the “bottom of the B class”.  

We deserve, by these criteria, to be downgraded. There are redeeming features, including institutional strength – and the Constitutional Court’s ruling on Pres Jacob Zuma’s Nkandla pay-back.       

If it happens what will it mean for the rand, the JSE, inflation, interest rates?

There is an argument to be made that South African markets were priced for the worst at the start of this year, including the bond market and currency market, in particular. From this, it follows that if a downgrade occurs, it is already “in the price”. 

By contrast, anything that points to South Africa staving off a downgrade or showing signs of stability and, ideally, structural strength, will help the rand and the bond market.  

To some extent this seems to be happening, with the rand and bond prices improving around the reappointment of Pravin Gordhan as finance minister, the February budget and the Constitutional Court ruling, among other things.       

Any advice to prevent a downgrade?

This has been well covered in other areas. I think that the most important (issues) relate to squaring up to South Africa’s structural problems from a socioeconomic perspective, including low growth, entrenched unemployment and grossly skewed income distribution.  From an institutional perspective, it is critical that integrity is preserved and independence maintained and enhanced. 

Greg Judin

Head of Treasury & Capital Management: Standard Bank Wealth.

What do you think the chances are?

The chances are high that one or more of the international ratings agencies will downgrade the SA Sovereign to sub-investment grade status before the end of 2016.

 The rand? The rand has already weakened considerably since December 2015, with the market broadly having priced in the possibility of becoming sub-investment grade. However, it is likely that there will be further rand weakness if a downgrade occurs, for example due to foreigners withdrawing funds invested in South African equity and debt markets.

The JSE? The JSE is likely to suffer losses from the downgrade. Many offshore investors (such as asset and fund managers) are required to diversify away from sub-investment grade jurisdictions, while others simply choose to. This is likely to lead to foreigners selling South African equity investments and thereby driving the price downwards.

 Inflation? While not expected to have a direct impact on inflation, the downgrade could lead to a weaker rand, and with South Africa being dependant on imports, this will result in the cost of imported goods and services increasing, which in turn could increase inflation.

 Interest rates? South Africa is already in an upward interest rates cycle as the SA Reserve Bank seeks to contain inflation. The potential increase therein might lead to further rate hikes.

Any advice to prevent a downgrade? The Finance Ministry has the downgrade as its top priority at present, and is placing specific focus on narrowing the country’s trade and budget deficits. In particular, widening the tax net in South Africa and curbing government expenditure are two direct means of strengthening the fiscus and avoiding a downgrade. It is also important to stimulate economic growth in SA.

David Shapiro

Deputy Chairman, Sasfin Securities

What do you think the chances are?

The prospects of a rating downgrade have become a national issue that has suddenly alarmed our populace, questioning whether they could do something to prevent it without really realising the reasons and implications. 

Rating agencies are financed by investors to assess the ability of sovereigns (countries) and corporates to make regular interest payments on their debts and eventually repay their loan obligations. They haven’t exactly covered themselves in glory in the past decade having been responsible for giving thousands of the toxic investments that ignited the financial crisis in 2007 a clean bill of health. 

South Africa’s credit rating has been in decline for the last few years, the outcome of the deteriorating health of the global economy, but also because of a number of shortcomings domestically. The list is extensive – it includes electricity shortages, an unaffordable government wage bill, persistent (and violent) labour strikes, corruption, cronyism, high crime rates, a low skill base and enforcing political idealism at the expense of creating jobs. Falling commodity prices (a consequence of a shift in China’s economic imperatives) and a severe drought in the country over the past 12 months have reduced our growth outlook immensely. We’re forecast to grow well below one per cent this year which is a third of the global average. 

The agencies worry that lower government revenue and rising spending obligations, especially for government’s wide-reaching social programmes, will weaken the country’s ability to meet swelling interest payments and capital repayments. With South Africa running both a budget and current account deficit, rating agencies fear more and more of the country’s revenue collections will go to meet debt obligations at the expense of investment in expanding the economy. 

Finance minister, Pravin Gordhan has laid out a bold plan to improve our fiscal position and address the rating agencies’ concerns. The big question rating agencies ask is: Does the government have the political will and competency to introduce the necessary reforms, particularly against the backdrop of the recent events? Their agencies’ assessment of this issue will determine our rating.

If it happens what will it mean for the rand, the JSE, inflation and interest rates?

A downgrade might not have an immediate effect on our market but over time it will weaken our appeal as an investment destination.

I think the rand and interest rates have to a large extent discounted a downgrade and the JSE is hardly impacted by the local economy. With over 70 per cent of JSE firms’ earnings (on a weighted basis) coming from abroad, the direction of our market is swayed by international events.

At present the rand and our bonds are in demand as foreign investors seek yield at the expense of safety, but as things normalise in the future, weak economic growth and political uncertainty will take its toll.