What does Junk Status mean for SA?

Cape Town – Ratings agency Standard & Poor’s (S&P) will on Friday afternoon announce whether South Africa has been downgraded to junk status, or whether it will live to fight another day.

Both S&P and Fitch rate SA’s foreign currency government debt at the lowest rung of investment grade (BBB-), while Moody’s recently affirmed SA’s sovereign rating at one notch higher within investment grade (Baa2).

These are the 10 things you should know about Friday’s ratings D-Day, as highlighted by Herman van Papendorp, head of investment research and asset allocation at MMI Investments and Savings:

1. Breathing room: While a downgrade to junk cannot be ruled out in June (particularly on the Fitch ratings outlook next Wednesday), it is more likely that both ratings agencies will want to first assess fiscal realities in the mini budget in October 2016, as well as developments on the domestic growth front before taking the big step of classifying SA’s debt as junk.

2. What makes SA stronger: South Africa has less than 10% foreign currency-denominated debt, meaning the deprecation of the rand has not hit the overall outstanding government debt. Many countries are not as fortunate and often their debt skyrockets, forcing them to turn to the International Monetary Fund for bailouts.

3. The next hurdle: If SA passes the June hurdle, agencies will watch government closely to see if it constrains the civil servant wage bill, whether it downgrades its growth forecasts, how it moves ahead with the mining charter revisions, whether it passes the land expropriation bill and if it allows labour reforms to remain stuck at Nedlac.

4. When ratings downgrade will hit you: If SA gets downgraded, it will cause the rand to weaken, leading to expected higher inflation, triggering an interest rate response from the Reserve Bank, which after three to four quarters will start impacting negatively on domestic demand growth.

5. Your taxes will go up: If SA gets downgraded, pressure will be placed on the fiscus due to higher interest costs and lower growth, higher taxes will be forthcoming, and cutbacks on government expenditure would be inevitable.

6. Who will be most affected: If SA gets downgraded, middle- to higher-end consumers (through higher personal taxes and interest rates and a negative wealth effect) and the middle- to lower-end consumer (through higher inflation and VAT and lower employment) will be adversely impacted.

7. How the rand will respond: If SA gets downgraded, the rand might not deteriorate much more. This is because the rand is less than 15% away from its all-time lows reached after the 1997/98 Asian and emerging market crisis and the subsequent 2000/01 Dot-com crash, which means a lot of bad news already seems to be discounted by the rand.

8. How the bonds will respond: The same applies to SA’s domestic bond yield. If there is a downgrade, there might not be that big a reaction, as indications are that SA’s debt is already rated similarly to other sub-investment grade countries.

9. What will happen to FDI: The same could also apply to foreign direct investment. SA has not participated in the recovery of emerging market net portfolio inflows in recent months. During March and April, it recovered 77% of the outflows experienced over the second half of 2015, but continued to experience outflows over the same time period. This implies SA’s idiosyncratic risk factors have already been factored into the investment decision-making processes of investors.

10. Will global investors dump SA? Global bond investors will not necessarily be forced to sell their holdings if one rating agency takes SA’s foreign currency rating down to junk level. The ratings have to be downgraded by three full notches by S&P and two notches by Moody’s, which would then trigger a forced selling by benchmark-cognisant investors. Such an outcome is still some time off.

 

Source: fin24

Author: MC World

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