Reform terms need some very practical goals
ALL YEAR, markets have been preoccupied about the possibility of a ratings downgrade to non-investment grade for South Africa. Throughout the past 11 months investors, business leaders and ordinary South Africans have been at pains about the possible implications of junk status.
All three ratings agencies – Standard and Poor’s, Fitch and Moody’s – have delivered ratings decisions that affirm South Africa remains investment grade. Standard and Poor’s decision to downgrade the component of debt issued in rands brings it in line with Moody’s, while Fitch now holds the most negative view on South Africa’s credit relative to the other two.
Lion’s share of debt
Ratings agencies assess the debt issued by the National Treasury in different currencies – local and foreign. The lion’s share of debt (90 percent) issued by the Treasury is in local currency, while the remainder (10 percent) is allotted in foreign currency – mainly in US dollars. This construct provides a solid framework for South Africa to manage debt effectively and cushions the domestic economy from exposure to foreign currency moves, which could have adverse effects on the stock of foreign liabilities. It was not surprising that South Africa kept its investment grade status following the review by all three ratings agencies – despite the unsatisfactory and deteriorating economic situation.
Domestic outcomes are not commensurate with the conditions historically observed elsewhere in emerging market countries when they were downgraded to junk status.
Typically, during episodes of downgrades into junk, most countries were experiencing a banking crisis, a currency crisis and a need for external funding, such as a bailout from the International Monetary Fund (IMF).
Standard & Poor’s has provided evidence that of about 20 countries downgraded to junk since the 1970s, only eight managed to regain the coveted investment grade. It was a long and arduous road back as it took on average six years for the eight countries to return to investment grade.
What is clear from the example of the 20 downgraded countries is that the economic outcomes during a downgrade to junk status were much more dire than what is currently observable in South Africa.
Case studies from South Korea in 1997, Colombia in 1999, Romania in 2008 and Hungary in 2011 reflect a situation where there were outright economic crises, punctuated by sharp declines in gross domestic product growth and an inability by the relevant fiscal authorities to cope with the situation without IMF assistance.
On balance, the likelihood of such adverse economic scenarios remains distant for South Africa and that is why it ought to remain investment grade.
Investors wonder what the prospects are of South Africa being removed from global benchmarks as a result of downgrades and a deteriorating outlook.
Benchmarks
South Africa remains firmly in investment grade on the component of debt issued in local currency (the 90 percent). Most benchmarks use the local currency rating and, on this measure, the likelihood of South Africa triggering exit criteria on global bond benchmarks remains remote.
Ratings agencies can leave a country’s negative outlook on investment grade for up to 24 months. There have been repeated calls to lift domestic economic growth, especially through a clear and implementable reform agenda.
To this end some progress has been made by the National Treasury, but more needs to be done. The vague term, “economic reforms”, needs to be demystified and broken down into practical goals.
Reforms really are microeconomic in nature and require a rethink – such as economic development aimed at regions, cities and municipalities. Without reforms, the conversations with ratings agencies in 2017 will prove much more challenging and the battle to hold on to investment grade much more difficult.