What not to do

If SA loses its investment grade credit rating it is likely to experience a recession that will last up to two years. This is the conclusion reached by Standard Bank, which researched the economic fall-out that hit six of SA’s peer countries (Brazil, Bulgaria, Croatia, Hungary, Romania and Russia) after they were downgraded to noninvestment grade in the past decade.

While falling into recession was the average experience, much depends on government’s reaction to a downgrade. Brazil is an example of how not to behave.

“Should the SA government not stick to its fiscal targets, the outcome may be much like that of Brazil,” according to the researchers. “This may not only kickstart a spiral of further currency weakness, but also weaker government bond yields, higher policy rates and weaker growth.”

On the other hand, since the average experience was that a country’s currency dives on the threat of a downgrade but then stabilises after the actual event, it may imply that SA has seen the worst of currency and bond weakness as long as it is able to maintain fiscal discipline after a downgrade.

National treasury in its 2016 Budget Review says that, in a more benign scenario, a downgrade to junk status would probably lead to a short-term spike in interest rates and further weakening of the rand.

In a less favourable scenario, it could trigger a sharp reversal of capital flows and precipitate a recession. In such an event, aggressive austerity measures would likely be required to ensure fiscal sustainability.

The Reserve Bank estimates, based on the experiences of 70 countries, that if SA is downgraded to junk status this would likely cause short-term rates to rise by 80 basis points (bps) and long-term bond yields by 104 bps, raising the cost of investment for both the public and private sectors. The rand would also likely fall, further fuelling inflation.