One investment grade remains, which is enough…
On the 24th of November 2017, Standard & Poor’s downgraded South Africa’s government debt denominated in local currency to sub-investment grade, and debt denominated in foreign currency to BB from BB+.
Two of the three major ratings agencies now have South Africa’s foreign and local currency government debt classified as so-called ‘junk’. Only Moody’s retained its local currency rating at the lowest level of investment grade, but has placed the country’s credit on review for a downgrade.
The rand has heaved a sigh of relief, which is likely to continue until the next significant events later this year and early in 2018. These include the possibility of a new board for state owned entity Eskom, a decision on tariff increases from the National Energy Regulator, the ANC Elective Conference and the delivery of the Budget in February.
Modest impact on financial markets, the rand and ordinary citizens
South Africa has a sophisticated financial market and the impact of Standard and Poor’s announcement on financial markets has been mild. The rand dipped against major currencies after the news, but has since strengthened.
If we received a downgrade from two ratings agencies, the market reaction would have been more severe. As it stands, the downgrade does not mean that government debt is to be excluded from the World Government Bond Index and other important indices.
However, South Africa needs to retain one investment grade in its local currency long term sovereign debt from the three key agencies to remain in key global indices. If not, it could risk significant currency outflows, which could cause the rand to weaken and higher bond yields.
All eyes on the next review in April 2018
If South Africa is moved to sub-investment grade by all three agencies, there will be a significant reaction in the markets. For now, however, the country retains Moody’s investment grade local currency and foreign currency debt rating.
Moody’s has decided to wait until the ANC Elective Conference next month and the February 2018 Budget before re-assessing the country’s creditworthiness. The agency has said it will downgrade South Africa if its economic, institutional and fiscal strength continue to weaken. Similarly, Standard & Poor’s has also stated that it could deliver further credit rating downgrades in the future.
What the agencies will be looking for are, among other things, the likelihood of South Africa repaying debt, fiscal discipline and consolidation, stronger policy making and signs of investment and economic growth. These will go some way towards protecting the economy from outside shocks and help retain an investment grade credit rating.
In essence, downgrades raise the cost of funding and it becomes more expensive for the government to borrow money. This reduces the amount available for what South Africa needs most, such as housing, education, healthcare and social grants.
From a ratings agency perspective, next April is when we see what Moody’s delivers in terms of its country rating review.
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by Dirk Meissner