Why credit ratings matter
Three of the world’s major ratings agencies – Moody’s, Fitch and Standard & Poor’s – are reviewing SA’s credit rating. The Conversation Africa’s asked Mampho Modise to explain the significance of the reviews
What do the agencies look at in the process of reviewing a country?
In their rating methodologies, ratings agencies have developed rating criteria for assessing the performance of key macroeconomic and socioeconomic indicators.
By assessing the indicators, the agencies are able to determine the borrower’s ability and willingness to honour debt obligations.
When reviewing the sovereign ratings, rating agencies hold discussions with various stakeholders in government, labour, civil society and the private sector.
What do they do with their results?
Once their reviews are concluded, the agencies will announce credit rating opinions which will reflect the borrower’s creditworthiness.
That is, the likelihood that the borrower will pay back a loan within the confines of the loan agreement, without defaulting.
A high credit rating indicates a high possibility of paying back the loan in its entirety without any issues. A poor credit rating suggests that the borrower has had trouble paying back loans in the past, and might follow the same pattern in the future.
The credit rating opinions are used by various stakeholders and for different reasons.
Firstly, investors use credit ratings as a guide to their investment decisions.
Secondly, for corporations and governments that want to raise money in the capital market, a favourable rating means a country will be able to obtain funds at a lower cost.
Lastly, governments could also use credit ratings as a measure for gauging their performance relative to peers to effect improvements.
Which political developments in South Africa are likely to have an impact on the reviews?
A few areas of concern have been cited. The outcome of the 2016 local government elections is one. The ratings agencies are concerned that a drop in the voter percentage could result in fiscal loosening to draw votes back to the ruling party.
Another concern is the charges instituted against Finance Minister Pravin Gordhan that were later withdrawn. This threatened the institutional stability and integrity of National Treasury.
And the political disagreements on the findings of the state capture report threatened the institutional independence of the Office of the Public Protector and the courts.
Finally, the upcoming elective conference for the governing ANC in 2017 is raising a concern on policy continuity and predictability.
What happens to a country downgraded to “junk” status?
“Junk” status is associated with high risk; therefore, high borrowing costs. This is the main reason a sovereign has to avoid being downgraded to a junk, or subinvestment grade.
For fund managers [that are representing the investors] a downgrade to junk status means they will have to sell the assets [bonds] they hold. Their mandates require that they only invest in investment grade assets.
For an ordinary person it means paying more interest, leaving little money for savings and expenditure on rent, school fees and food.
For governments it means allocating more to debt servicing costs [interest payment].
Less money will be available for social grants, investment priorities, creating jobs and ultimately reducing the GDP growth potential of the country.
Is it possible for a government to simply ignore its ratings?
Not really. Solicited credit ratings ensure easy access to international capital markets. Favourable credit ratings imply low borrowing costs.
The South African government has solicited credit ratings from the top agencies to ensure that it can easily and cheaply access foreign funding needed to accomplish its economic development agenda.
South Africa, therefore, can’t ignore the credit ratings assigned to it, especially given that foreign investors hold more than 30% of government debt.