‘Real’ junk status looms

DOMESTIC DEBT SHOULD BE MAIN PRIORITY TO AVOID ECONOMIC SHOCKS

Negative outlook of Moody’s towards SA’s ability to repay debt signals downgrade is imminent.

If Moody’s is threatening to downgrade SA’s domestic debt, one can assume other rating agencies are likely to consider even stronger decisions.

The negative outlook of credit rating agency Moody’s regarding the SA government’s ability to repay its debt is a clear signal a downgrade of the country’s domestic debt to sub-investment grade (junk status) is imminent.

Many investors and institutions do not yet view SA government debt as true junk, as local currency-denominated debt is still regarded as investment grade.

The economic aftershocks of a downgrade of domestic debt are expected to be roughly six times as severe as the junk status downgrade of SA’s external debt obligations.

The exposure of foreign investors and institutions to rand-denominated government debt makes up close to two-thirds of this debt. SA’s junk status debt is only about 10% of total government debt. If the other 90% is downgraded, SA debt can be seen as real junk. Moody’s has traditionally had the most positive credit ratings and outlook for SA. If it is threatening to downgrade SA’s domestic debt, other rating agencies are likely to consider stronger decisions. A single notch downgrade by Moody’s or Standard & Poor’s will immediately put SA’s domestic debt at junk level.

It is especially worrying that Moody’s implicitly says a single shock to the economy may have a big effect on government’s ability, or willingness, to repay debt. And that appears likely as political risks currently overshadow all other risks faced by the economy. A downgrade could be triggered over the next six months by any of at least five critical factors:

A chaotic ANC elective conference in December that leads to political and economic uncertainty;

Further political interference regarding the mandate and independence of the SA Reserve Bank, the judiciary and National Treasury;

Political pressure to indirectly influence pension funds, such as the Government Employees Pension Fund, to provide emergency loan funding to state-owned enterprises, including SAA and Eskom;

Unplanned government funding or guarantees to state-owned enterprises; and

Political interference that could result in destabilising the banking system.

In addition to a major confidence shock to the economy, a junk status downgrade of SA’s domestic debt may lead to further shocks, including: Tax increases; Problems for pension funds that aren’t allowed to invest in sub-investment grade instruments; and

A general downward economic spiral that can lead to further downgrades.

It is time citizens and the business community start to take the possibility of a domestic junk status seriously. The impact of the current junk status of external debt is relatively small compared with the potential impact of a domestic downgrade. A domestic rating downgrade will be the real junk status that may impact every South African and a wide range of businesses.

Dr Conrad Beyers,is Barclays Africa Chair in Actuarial Science.