Scenario still exists: SA can go from junk to comeback kid
It is no surprise that Moody’s Investors Service has finally downgraded SA to subinvestment grade, or Moody “junk” .’This s rating change to that aligned of Fitch and S&P Global Ratings, with all three agencies on a negative outlook.
Last week Fitch went a step further and downgraded again, making it the most bearish agency at present, two notches below investment grade. Moody’s remains one notch below investment grade, while S&P’s split rating (local- and foreign-currency ratings) are one and two notches below investment grade. The question that arises: is “junk” just “junk”?
The first tier of subinvestment grade (Ba1-Ba3 for Moody’s and BB- or BB+ for S&P-Fitch) is described as “speculative”, whereas the tier below this (B1-B3 for Moody’s and B+ and B- for S&P-Fitch) is described as “highly speculative”. Another 11 to 12 notches down is the area in which countries are in default.
As an extreme example, Argentina’s sovereign rating is now seven notches below investment grade — territory generally described as “default imminent with little prospect for recovery”. So while “imminent default” still seems a faraway prospect for SA, the country still faces the problem of being junk-rated with negative outlooks across all three agencies — the worst place to be during a crisis.
SA faces two scenarios: establishing itself at the very top of subinvestment grade on stable outlooks across all agencies, leaving investmentgrade status just one step away; or falling deeper into subinvestment-grade territory to the point of no return.
Let us consider the more upbeat scenario first. Suppose a country falls one notch into junk on negative outlooks across all agencies but quickly decides to take the correct measures to strengthen its GDP growth outlook and thus its fiscal position. In SA’s case, this would mean reversing the factors that prompted the downgrades and negative outlooks to begin with, by finding a credible strategy to stabilise debt, create a stronger GDP growth outlook and reduce the burden of inefficient state-owned enterprises (SOEs).
If, hypothetically speaking, SA were able to do this, ratings agencies would eventually move to stable outlooks, and at just one notch below investment grade investors would be likely to start asking what the country needs to do for an upgrade back to investment grade. In the end SA becomes an investment opportunity, a “comeback kid” in emerging markets. The longer this persists, the more inflows the economy receives, and the rest follows.
Potentially encouraging. But it also seems a reach for a country that was unable to gain sufficient traction on reforms through the eight years of persistent warnings from ratings agencies. That, unfortunately, placed SA on a weak footing to begin with. Even the first two years of Cyril Ramaphosa’s presidency haven’t provided sufficient government support for the Treasury to place SA on a path of debt stabilisation. So with at least one of the three ratings agencies it sits two notches below investment grade after Fitch’s decision.
The challenge with an emerging market that moves deeper into junk territory is that the prospect of climbing out becomes more remote.
Put another way, most governments do not have the appetite for the often unpopular political effort required to achieve two or more upgrades. This can lead to policy instability, which increases the country’s risk premium, adding to the borrowing costs associated with moving deeper into junk.
THE CHALLENGE WITH AN EMERGING MARKET MOVING DEEPER INTO JUNK IS THE PROSPECT OF CLIMBING OUT GETS EVER MORE REMOTE
SA has a clear advantage in that its institutional strength, in the ratings methodology, scores two notches above investment grade. This means strong institutions should push the government harder to accelerate reforms to improve the economic growth outlook given that this is the cheapest way to reduce the funding costs of a subinvestment-grade rating.
The Reserve Bank has already agreed to purchase government bonds in the secondary market, but only to ease dysfunctional markets. The Bank has been painfully clear it is not an attempt to reduce yields (reducing borrowing costs), nor is monetary policy nonfunctioning. However, the risk is that if lower interest rates encourage issuance of shortdated bonds at lower borrowing costs, a greater refinancing risk could emerge if the government cannot improve the economic growth outlook.
Herein lies the biggest test yet: though SA benefits from investment-grade institutional strength in its junk rating, this is exactly what the country risks losing if the government cannot find a way to improve the economic growth outlook to stabilise debt.