S&P & Fitch Global Ratings cut South Africa’s sovereign credit rating to junk in April after Zuma reshuffled his Cabinet (again). Moody’s is holding judgement (for now). But what does this mean & why did it happen & how will it impact you? I thought I’d give you a layman’s summary after listening to it explained by Dennis Dykes, Chief Economist of Nedbank Group Limited at a technical update given to SAICA members at the beginning of May.
Moody’s, S&P & Fitch are the 3 biggest global credit rating agencies and therefore are credible and Foreign Investors rely on their opinions. Though they are not infallible – to see evidence of this you should watch the movie “The Big Short” which explains in non-Accountanteese how the USA housing market crashed in 2008/9 & the role they played.
What is a Credit Rating?
Sovereign credit ratings give investors insight into the level of risk associated with investing in a particular country and also include political risks. At the top AAA means very little chance of default & on the other end of the scale D means almost a 100% chance of losing money (or defaulting).
This table is a summary of the rating symbols used where the top 3 blocks are the Investment grade – a place where you get more assurance on your money being returned. The bottom blocks are non-Investment, Speculative or Junk where the risks have increased and you have less certainty of return on your money.
How have we rated in the past?
As you can see in the accompanying graph we have had Investment rating by all 3 Rating agencies since 2000. The ratings have however been declining steadily since 2012.
Graph Source: Dennis Dykes presentation 3 May 2017
Why were we downgraded?
The 4 main reasons why we have been downgraded are as follows;
- Sustainability – can we pay back the money we owe? This is looking less & less likely and the major reason for this is that the Government wage bill continuously increases leading us further into debt while capital public expenditure is declining. So what? Capital expenditure (i.e. on assets & infrastructure) is limited expenditure & once completed you are left with an asset which should add to your income. However, increasing staff costs are an expense & a continuous outflow of revenue. So now the government is effectively borrowing money to pay it’s daily expenses which is a never ending cycle, however if they were investing in capital the capital would have a limited outflow of money & should then contribute to income in the future.
- Increase in Contingent Liabilities – this is a fancy term which means the Government’s guarantees on public exposure, i.e. if one of the State owned companies listed here can’t repay their debts, government have kindly offered to do so for them… as we have seen time & again with SAA. This list leaves us with a R308 billion exposure! The government have promised payment out of the limited taxes collected, should it be required.
3. Uncertainty around the legislative agenda. This needs little explanation as we can all see no one knows exactly from one day to the next which legislative frameworks & policies will be amended or abandoned.
4. Political “turmoil” – although the term may be politically incorrect, you all know what I mean!
What does this mean for us?
Unfortunately many portfolio investors (i.e. those investing for pension funds etc.) are not allowed to invest in Junk rated products due to the additional risk they carry which means less money could flow into the country. There is also likely to be a rise in government, private & consumer borrowing costs (interest rates).
How can we recover?
In short it will take us 5-7 years to recover to Investment status again & the next South African president will have to show sound policies are in place & being followed. The following are also key;
- Reform of State owned Enterprises which are sapping our resources
- Inclusion of the Private Sector and
- Implementation of the National Development Plan (NDP) which would resolve many of the Rating agencies concerns & is a solid plan… IF implemented!
It isn’t all bad news, as the Rand hasn’t dived like it did when Nene was replaced. The market appears to be waiting for political resolution (which may only happen in December when Zuma’s replacement is decided if opposition parties can’t change the staus quo before then). So we wait & see in hope of leadership that will implement the NDP & continue the sound work done in the past by some solid leaders such as Gordhan. In fact see what he has to say – http://ewn.co.za/2017/05/04/gordhan-not-all-hope-is-lost-for-sa