A look beyond SA’s downgrade hysteria

ican pension funds, which are required by law to avoid holdings that the ratings agencies consider speculative.

The loss of foreign funds means, first, that the government and private companies will have to pay more to borrow. That will squeeze state services as the government pays more on its debt. It could also affect investment by state-owned enterprises and private companies. Both will act as a drag on the slow economy.

Second, the outflow may push down the value of the rand, which is both good and bad for growth. On the upside, it makes export industries and tourism more competitive.

In recent years, depreciation has been critical for the survival of mines, as well as the upsurge in auto and other manufactured exports. But there is a price to pay: it also makes imports more expensive, which can add to inflation.

It’s not clear, however, if the downgrade will decisively affect capital flows.

From 2014 to 2016, foreigners sold R200 billion in South African stocks and bonds. That’s a core factor behind the depreciation of the rand. That outflow results, not from the ratings agencies, but from the end of the commodity boom. South Africa still depends on mining exports. The prices of metals and coal soared from around 2002 to 2011, but then fell sharply.

In constant dollars, prices of metals in 2011 were far higher than at any time since 1980, but then collapsed by well over half. Since then, growth has been much slower and harder to forecast.

The commodity boom turned South Africa into an attractive destination for inter national capital, especially because our sophisticated financial markets make it easy to invest.

From 2001 to 2013, the share of foreign holdings in the JSE climbed from 4% to 33%. With the end of the commodity boom, the figure dropped to 27% last year.

Foreign lenders were also increasingly important for the government. Only a tenth of South African debt is issued abroad. But the share of domestic bonds held by foreigners climbed from 13% in 2008 to 36% last year.

In short, capital flows into and out of South Africa essentially followed metals prices over the past 15 years.

From this standpoint, the ratings agencies trail the market, rather than lead it. Investors all follow the same signals – and the ratings agencies both reflect those indicators and communicate them.

A second issue is whether the ratings agencies are infallible policy pundits. Essentially they are dominated by three private companies – Standard and Poor’s, Fitch and Moody’s – that earn fees by helping investors estimate risks.

The ratings agencies have got it spectacularly wrong on occasion. In the run-up to 2008, at the height of an asset bubble, they rated a lot of truly toxic housing bonds as topflight risks. As a result, a lot of institutions bought them – and ended up losing billions. Their perspectives should be considered like those of any other experts: tested against evidence as well as other views.

Research shows that ratings are mostly determined by economic growth. When the GDP is flying high, sovereign risk ratings improve; when growth slows, they drop. This certainly fits the South African case. Growth began to improve from the early “noughts” as metals prices climbed internationally – and we emerged from “junk” status around the same time. Growth slowed dramatically as metals prices crashed in 2011 and our sovereign risk ratings declined in step with it.

If it’s any comfort, we are not alone in this process. Brazil and Russia were both downgraded to junk after the commodity boom ended. In fact, half of all countries with risk ratings are below investment grade.

In the uproar about the downgrade, the real questions often get overlooked. Most urgently, the question is how civil society and citizens can protect our democratic institutions from the kleptocratic onslaught. In the longer run, we need to do more to ensure that growth is more equally shared.

Because in the end, only a more equitable economy can secure stable economic growth. The ratings agencies won’t guide us in meeting either of these core challenges.

Makgetla is senior economist, Trade and Industrial Policy Strategies, Pretoria.