Living will be more costly as ‘junk’ we are

WITH the significant political and policy uncertainty, high levels of corruption and many failures of governance, the rand and local South African bonds have performed surprisingly well.

It was a lot better than expected! Despite this, we are now officially junk squared.

Two of the top rating agencies have now downgraded SA to junk status with the third eagerly waiting to do the same, which then allows us the official title of junk cubed!

November 25 saw the major ratings agencies, which used to give South Africa the benefit of doubt, finally lose patience.

Credit ratings agency S&P Global downgraded South Africa’s credit rating to full junk status, while its counterpart Moody’s placed the country on review for downgrade.

The agency remained the most generous of the big three credit rating agencies in that it was the only one still to rate both foreign and local currency South African government bonds as “investment grade”. However, it placed the country on review for a downgrade.

This decision still takes the country dangerously close to all-round junk status.

There is severe pressure on the fiscus, as tax revenue growth remains severely constrained by the lack of economic growth and some poor government decisions.

As a result, preventing another ratings downgrade from the remaining agency will be difficult.

South Africa could face significant foreign investment outflows through forced selling of bonds with capital flight causing a severe shock to the economy resulting in government’s funding costs increasing.

In an already fiscally constrained environment, this would put pressure on government to increase taxes, tightening the already stretched consumer pocket, and therefore South Africans would need to cut expenses and plan even more carefully.

The shock dealt to business and investor confidence will be greater and longer lasting, undermining the growth potential and associated job creation potential of the economy (something which we have been grappling with for many years).

A weaker rand would result in higher inflation and ultimately higher interest rates, which would, in turn, increase the price of fuel (this has a ripple effect on the cost of production and consumer prices), luxury goods and other imported commodities.

With the petrol price going up‚ food prices have to go up. The raw ingredient of petrol is oil, which is bought in dollars. So when the rand weakens, oil prices rise and so does the petrol price.

The knock-on effect of a weaker rand is higher transport costs. Higher transport costs affect the price of everything moved by trucks – from food to imported goods and anything you buy at a shop.

Food is traded on international markets in dollars. The price of rice‚ maize‚ sunflower oil‚ wheat and sugar are set in dollars. That is why a weaker rand means we pay more for food‚ especially if it is imported. If the rand goes into free fall, households will suffer.

When giving their reasons for downgrading the SA government’s foreign debt‚ Standard & Poor’s predicted that interest rates would rise‚ regardless of their downgrade decision. “We think that ongoing tension and the potential for further event risk could weigh on investor confidence and exchange rates‚ and potentially drive increases in real interest rates.”

If interest rates go up‚ the cost of borrowing goes up. It increases your credit card repayments and the amount you need to pay the bank every month for your short-term loan or car and home loan.

Nedbank chief executive Mike Brown said: “The real effect of the downgrading will be on the up-andcoming middle class, who are teetering on the brink of making the middle class. Suddenly their debt becomes more expensive and they can’t afford it and their home loan is foreclosed or they have their cars taken away by the bank due to missing repayments.”

Analysts also expect inflation to rise because of S&P’s decision and the Reserve Bank often hikes interest rates in response to higher inflation.

Taxes may rise. The government borrows almost monthly to pay its bills as it spends more than it earns. Many institutions such as banks are not allowed to invest in junk status debt.

Government will need to borrow from people, who are willing to invest in higher risk debt and this is more expensive. Junk status ultimately means the government will pay much more to borrow money.

The government then must either cut spending or increase taxes to cover the extra costs spent on debt. It means more taxes in the end. Taxes are usually adjusted when the annual Budget is unveiled in February and normally implemented in April‚ so a potential increase will likely not affect South Africans immediately.

So, what’s next!? Bad news if good decisions are not taken at the ANC conference from December 16 to 20.

The remaining international rating agency has put out statements with dire warnings about a potential downgrade. Political risks to standards of governance and policy-making have increased and continue to do so. The ball remains in our court for now!