SA joins bad boys in the hood as ratings agency gives growth rate a black mark
We are no longer in a very nice neighbourhood when it comes to ratings. After Friday night’s downgrade by S&P Global Ratings, SA is in exactly the same ratings neighbourhood as Turkey – whose government recently extended a state of emergency for the fifth time, which has resulted in more than 50,000 people being arrested and whose institutions S&P politely describes as “weak”.
Like Turkey, SA now has a double B foreign currency rating, which is two notches below investment grade, and a local currency rating that is one notch above that at double B-plus. However, unlike Turkey, which is on negative outlook, S&P put SA on stable outlook – so no more downgrades for now.
Then there’s Brazil, which has come out of two years of deep recession, has a government debt burden that makes SA’s look amateurish and where, in S&P’s words, “ongoing corruption investigations have become part of Brazil’s political landscape”. At least they prosecute their corrupt leaders.
Brazil’s rating, too, is on negative watch and, unlike SA’s, the foreign rating on the country’s hard currency debt is the same as the local currency rating.
Ratings are a relative game – the agencies look at each country relative to the peers on its ratings ladder when they evaluate whether the rating should go up, down or stay the same.
It’s the foreign currency rating that matters in the global comparison charts.
S&P tends to look at the foreign currency rating as the core but SA, and a handful of other large emerging markets such as Turkey and Mexico, get notched up on the local rating thanks to well-functioning domestic financial markets, floating exchange rates and so on.
The gap between foreign and local is an emerging markets thing: in developed markets in Europe and the US almost all of the governments’ borrowing is done at home, in their own currencies, so it’s not relevant to have different ratings.
SA gets the notch-up from S&P (though not from Moody’s Investors Service) because it has deep and liquid domestic capital markets that enable the government to do much of its borrowing in its home market, and because it has a fully open financial account on its balance of payments and a credible central bank. Indications are that SA is not in any danger of losing that uplift, although S&P had already cut it from two notches to one a year ago.
Much of the attention in the wake of Friday’s downgrade has been on the fact that S&P had junked our local currency rating, on SA’s rand-denominated bonds, putting the country at risk of very sizeable capital outflows if Moody’s followed suit.
Moody’s still rates SA well above S&P. There’s been less focus on the fact that S&P also cut our foreign currency rating, which is now deeper into junk than it was before — which is how we come to be rated on par with Brazil and Turkey, and well below emerging markets such as Indonesia and India, which have been upgraded in the recent past to the investmentgrade, triple B-minus foreign currency rating SA used to enjoy until President Jacob Zuma booted Pravin Gordhan out of the finance ministry in April.
What’s striking about all these other markets is how fast their economies are growing relative to SA’s.
That offsets many of the negatives for the ratings agencies, who are, after all, there simply to judge countries’ ability and willingness to meet the interest payments on their debts and repay the capital — not their human rights records.
Just as customers’ income earning prospects are key to the way banks rate their creditworthiness, so countries’ growth prospects are key to the way agencies rate their creditworthiness. Their institutions matter crucially, though, because of their economic influence.
In Friday evening’s report, S&P emphasised that SA’s growth rate and growth prospects were the weakest among the emerging markets it rated. Even Brazil is expected to grow 1.5% in 2017, and above 2% in coming years, though its government is running a fiscal deficit of almost 9%.
Brazil doesn’t have SA’s deep local funding market, hence there is no gap between its local and foreign ratings.
Turkey gets some credit for its financial sophistication and its 5% growth rate. This is expected to weaken to 3.7% on average to the end of 2020, mainly because of the country’s horrible politics. But that’s a rate SA can still but envy.
S&P’s most high-profile recent emerging market upgrade was Indonesia, which is growing at more than 5% a year and was raised to investment grade on reduced fiscal risks and “realistic budgeting”.
SA, sadly, has the realistic budgeting and much stronger institutions and financial markets than many of these emerging market countries. It just doesn’t have the growth. And unless it can fix that, its neighbourhood could get worse.