Many economists and analysts are fatigued by discussions on the credit ratings agencies downgrade of South Africa and the impact it could and would have on markets. The simple reason is that they (and myself personally) have been doing briefs like these for the last several years for each notch down the ladder. For me, its less about the specific rating than it is about the trend which for the last several years has remained unabatingly negative. In fact, it was one of the last topics I spoke on at the S&P Conference before I left South Africa.
As at Friday’s downgrades, South Africa is now at the lowest levels across the 3 major agencies since the transition to a democratic South Africa in 1994. In fact, it was in 2017 that S&P was the first of the major ratings agencies to move South Africa into sub-investment grade amid fiscal deterioration and little evidence of the ability and some would argue, willingness to arrest the slide.
The table below aligns the ratings schedules and shows how firmly ensconced SA is now in the non-investment grade class and in fact sits on the cusp of ‘high speculative’ debt which is certainly an unenviable position.
The outlook from Moody’s and Fitch remain negative which implies further downside pressure to the rating while S&P has maintained a ‘Stable’ outlook at this stage. S&P is usually one of the most critical ratings agencies and as such, its outlook statement is interestingly more upbeat than its peers.
I will not go into the lengthy detail around the position suffice to say that SA has been sailing too close to the wind for some time and that the COVID crisis merely exposed the cracks which thus far were uninspiringly being papered over poorly.
What are the pressure points? Well, just look at my pieces on the MTBPS here and here, and you can see that the slide in sovereign finances is certainly unsurprising. In fact, for Moody’s it is downright disappointing considering that they were the one rating agency who gave SA the benefit of the doubt and in fact are still a notch above their peers in their assessment.
What does it mean for the average investor?
Firstly, the cost of borrowing in South Africa (measured by the 10 year government bond yield) has crept up from around 6.5% at its low to around 9 % currently. It did see a spike to around 13% during March this year which has subsequently corrected.
By contrast, peers in the EM complex, such as Indonesia and India currently pay around 6%. Similar rated peers like Turkey currently pay around 12%. It means SA pays 50% too much in interest relative to if it started doing things right.
Emerging market yields in general have declined regardless of ratings, given the prevalence of low yields globally and the global carry trade which sustains the voracious search for yield in an ever-decreasing yield world.
This means that the cost of borrowing for the South African government (and by extension every SA borrower) has crept up and is a lot less competitive than it should be in a world where global macro factors have been supportive of borrowers.
From a government and social context, it means that the share of budget swallowed by debt service remains too high and will crowd out the ability to not only deliver services but also to invest in future growth as well.
Corporates in SA will also deal with the higher cost of funding by deferring investment. Remember, if the risk-free rate creeps up, it slowly erodes the viability of projects and investments by shifting the hurdle rate and required return higher. Lower investment feeds into lower growth and further constraints.
Many have been loathe to call it a debt spiral but the fact of the matter is that the EM universe is replete with worse case studies (like Argentina for one) which shows you how much worse this can get unless the powers that be get serious about reigning in the purse strings, and taking the tough decisions when it comes to SOE’s and public sector wages (just two of the many pressure points).
Will these ‘hot potatoes’ stay too hot and mean that the rest of SA stays in the frying pan for longer, time will tell but judging by the ratings agencies assessments, its more a question of out the frying pan and into the fire?
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