South Africa is fully junked – what happens now?

 ·28 Mar 2020

Ratings firm Moody’s has downgraded South Africa’s credit rating to below investment grade, after three years being the only major firm to keep the country’s head above water.

Moody’s downgraded South Africa’s long term foreign and local currency debt ratings to ‘Ba1’ from ‘Baa3’ with a negative outlook.

The move did not come as a big shock to investors and analysts, who have been questioning Moody’s positioning on South Africa over the years, following Fitch and S&P Global’s moves to junk the economy in 2017.

But even though the downgrade is not much of a surprise, its timing – in the middle of a global coronavirus pandemic where South Africa has just locked down most of the economy for 21 days – has left the country in a considerably weaker position.

And it’s one that the country will likely be unable to reverse in the near, or even medium term, according to Intellidex analyst, Peter Attard Montalto.

According to Moody’s the downgrade comes as South Africa is beaten down by unreliable electricity supply, with persistently weak business environment and low levels of investment.

The country also has a long-standing labour issue, and low levels of flexibility on policy. Effectively, South Africa has a lot of problems, and government isn’t (and can’t) move quickly enough to solve them.

While the coronavirus pandemic is mentioned in the report, the crux of the rating downgrade lies in the country’s other fundamentals.

The rand will likely weaken further when markets open on Monday, and is expected to hit over R18.00/$ in the short-term.

Government noted the decision by Moody’s to downgrade South Africa’s long term foreign and local currency debt ratings a notch below investment grade.

“The decision by Moody’s could not have come at a worse time. South Africa, like many other countries, is seized with containing the outbreak of the coronavirus (Covid-19), said Treasury.

“The impact of Covid-19 is felt across various sectors of the economy including the financial markets which experienced a significant sell-off in equities, bonds and exchange rates as investors retreated to safe haven securities amid the uncertainty.

The sovereign downgrade will further add to the prevailing financial market stress. These two events will truly test South African financial markets, it said.

“South Africa’s deep, stable financial sector and robust macroeconomic policy framework have always been flagged as a credit strength, including the South African Reserve Bank’s demonstration of a good track record in implementing credible and effective monetary policy and preserving financial stability.”

Treasury said that the interest rate for government, households and the broader economy is expected to increase. “While some market participants argue that the impact of a sovereign downgrade has already been priced in, it is difficult to stipulate with certainty the extent.”

“Therefore, to say we are not concerned and trembling in our boots about what might be in the coming weeks and months is an understatement,” said minister of finance, Tito Mboweni.

“It is with a heavy heart to note that all three major credit ratings agencies currently rate South Africa at sub-investment grade. However, every crisis presents an opportunity. The opportunity we have today is to unite and work together to address our challenges.

“We as a people have overcome insurmountable challenges in the past and we can still overcome. We shall rise. We have to rise. We owe it to ourselves,” Mboweni said.

What happens next?

Following the rating to full junk, South Africa will gradually see a loss in foreign direct investment, as it loses its place in the World Government Bond Index, which will likely happen at the end of April.

This will see around $5 billion (R88 billion) pulled out of the economy.

But that’s not the end of South Africa’s woes, Attard Montalto said, as he expects more ratings downgrades will come as government struggles to regain credibility.

In its report, Moody’s mentions that there is “even greater uncertainty regarding eventual stabilisation, in turn threatening South Africa’s access to funding at manageable costs” a scenario which is likely to stick, the analyst said.

Important indicators in this regard include the government’s ability over the next year or so to:

  • Contain the impact of global recession on the South African economy and to promote recovery thereafter;
  • Agree and begin to implement the structural reforms that would strengthen the economy;
  • Implement the framework for a reliable supply of power to the economy;
  • Implement Fiscal reforms to contain expenditure and enhance revenues are important milestones.

The analyst said that government is likely to fail or make little progress in any of these – particularly on the energy front.

“As a result of these factors, and our views on them, we forecast Moody’s will cut again in the next year. We also forecast that S&P and Fitch may both downgrade in the coming months on the coronavirus impact,” he said.

Can South Africa recover?

There are no quick or easy fixes for South Africa – and even if there were, government remains hamstrung by policy inefficiency and factionalism within the ruling ANC, he noted.

“We see virtually zero probability that South Africa will regain investment grade status in the three year forecast horizon we look at,” Attard Montalto said.

National Treasury – led by Tito Mboweni – had put in place an economic policy document in 2019 which addressed all of Moody’s concerns. However, stalling, particularly on the energy front – which was specifically called out by Moody’s – has made much of this ineffective.

“National Treasury must move with speed to re-establish credibility,” Attard Montalto said.

He said an emergency budget at the end of April after lockdown – laying out transparently what is going on with growth, the revenue impact and the implications for the fiscal framework and issuance – is crucial to ensuring Treasury keeps decent access to market for issuance into a hugely challenging April-July as the coronavirus impact hits.

However, he noted that while Treasury is fully aware of the weight of the downgrade, there are many within government (and the ANC), who ‘don’t care’, and will see this as a positive move, “freeing them of the shackles” of the ratings agencies.

“Something fundamentally has to break first for the politics to shift to reform. Maybe the deep scars left by coronavirus on the economy and a permanent step up in unemployment and down in output will be that, maybe failed auctions or going to the IMF will be that,” he said.

“This point, however, remains hard to see and hard to forecast. So for now it is up to Treasury to redouble the good fight.”

Read: South Africa downgraded to full junk status

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