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South Africa sank deeper into junk territory on Friday (November 20) after Moody’s Investors Service teamed up with Fitch Ratings to downgrade the country’s credit ratings.
Moody’s downgraded the local and foreign currency ratings to Ba2, two notches below investment grade, from Ba1, Bloomberg reported. The outlook remains negative.
Fitch downgraded the local and foreign currency ratings to BB-, three notches below investment grade, from BB, also with a negative outlook.
On Friday, S&P maintained its assessment of South Africa’s foreign currency debt three notches below investment grade, with a stable outlook.
The government has taken note of the credit rating decisions made by the rating agencies.
“The decision by Fitch and Moody’s to further downgrade the country is painful. The downgrade will not only have immediate implications for our borrowing costs, it will also limit our fiscal framework, ”Finance Minister Tito Mboweni said in a statement on Saturday (November 21).
“Therefore, there is an urgent need for the government and its social partners to work together to ensure that we maintain the inviolability of the fiscal framework and implement much-needed structural economic reforms to avoid further damage to our sovereign rating.”
S&P affirmed South Africa’s long-term local and foreign currency debt ratings at ‘BB-‘ and ‘BB’, respectively. The agency maintained a stable outlook.
According to S&P, the lockdowns associated with fighting the Covid-19 pandemic plunged South Africa into its sharpest quarterly economic contraction in the second quarter of 2020, leading to a large increase in the fiscal deficit and a rapid rise in public debt.
However, there are signs that the economy is beginning to recover in the third quarter.
Fitch downgraded South Africa’s long-term local and foreign currency debt ratings to ‘BB-‘ from ‘BB’. The agency maintained a negative outlook.
According to Fitch, both the downgrade and the negative outlook reflect high and rising public debt, exacerbated by the economic impact caused by the Covid-19 pandemic.
Furthermore, the country’s very low growth trend and exceptionally high inequality will continue to complicate fiscal consolidation efforts, he said.
Moody’s downgraded South Africa’s long-term local and foreign currency debt ratings to ‘Ba2’ from ‘Ba1’. The agency maintained a negative outlook.
According to Moody’s, the downgrade reflects the impact of the pandemic shock, both directly on the debt burden and indirectly by intensifying the country’s economic challenges and social obstacles to reforms.
Furthermore, South Africa’s ability to mitigate the impact in the medium term is lower than that of many sovereigns given significant fiscal, economic and social constraints and rising borrowing costs.
The government’s policy priorities remain economic recovery and fiscal consolidation, as outlined in President Cyril Ramaphosa’s economic recovery and reconstruction plan and in the Medium-Term Budget Policy Statement released in October, the Treasury said.
“The social pact agreed between the government, companies, workers and civil society prioritizes short-term measures to support the economy, along with crucial structural economic reforms.”
Treasury looking for positives
The Treasury further noted that rating agencies have indicated that South Africa’s rating strengths include a credible central bank, a flexible exchange rate, an actively traded currency, and deep capital markets, which should help offset low economic growth. and fiscal pressures.
“The government implores all members of society to adhere to all the necessary health and safety protocols to prevent a second wave of Covid-19 infections that would have significant adverse implications for the economy and plans to boost employment.”
Lower investment grade implications: what it means for the average South African
The Treasury said the impact of the Covid-19 pandemic hit South Africa at a difficult time. The recent downgrades saw South Africa reach its lowest credit rating levels of the ‘big three’ rating agencies since 1994.
“Economic growth has continued to decline regardless of attempts to reduce structural constraints.
“The financial strain on the government caused by the pandemic, weak economic growth, high wages and continued support for financially weak state-owned companies have weakened public finances and led the government to accumulate debt.”
The government has accumulated a debt stock of almost R4 trillion and spends approximately R226 billion on interest costs.
“If the cost of borrowing money increases for the government, it means that the government will have to cut social spending or tax more of the few people who are employed, which is bad for the country,” said the state financial institution.
Further downgrades will extend the impact of the lockdown restrictions, he warned. “These restrictions led to many workers being laid off as companies were temporarily closing doors and reducing operating costs.
“Without any disposable income and rising costs of property, it will be difficult to maintain a standard of living.”
The continued downgrades, the Treasury said, will translate into unaffordable debt costs, impairment of assets (such as retirement, other savings and property) and reduction in disposable income for many.
“The downgrades associated with Covid-19 have also led to the closure of many small businesses and the firing of several workers.
“Operating costs are expected to rise along with borrowing costs, supporting the rationale for shifting costs to consumers or laying off more workers,” he said.
Recent ratings results mean that South Africa needs to accelerate growth enhancement strategies to rectify debt accumulation and minimize costs associated with negative sentiment.
“Operation Vulindlela is a key initiative in this regard and demonstrates the government’s commitment to accelerate the implementation of critical reforms that boost economic growth and improve fiscal sustainability,” said the Treasury.
Mboweni’s medium-term budget last month showed plans to cut the government’s wage bill, which has risen 51% since 2008, as part of an effort to begin reducing the trajectory of government debt after 2026, it reported. Bloomberg.
The proposed wage freeze runs the risk of a backlash from politically influential labor groups already in a legal battle with the government to comply with an agreed wage deal.
If state wages cannot be cut, there is limited scope to offset measures in other areas of spending, Bloomberg said.
Sanisha Packirisamy, an economist at Momentum Investments, said the downgrade will also have the following implications:
- Higher borrowing costs for the government will crowd out spending on much-needed social and economic programs;
- A further blow to business sentiment could lead to lower fixed investment rates, weaker growth, and greater downward pressure on employment;
- An additional negative bias in the ratings could lead to a more depreciated currency, higher cost of imported goods, high inflation and limited degree to which the South African Reserve Bank can maintain accommodative monetary policy;
- On Moody’s scale, South Africa’s sovereign rating is now in line with Brazil’s, but above Turkey (B2), on the Fitch scale, South Africa ranks in line with Turkey and Brazil;
- At 234 points, South Africa’s five-year corporate default swap spread (CDS) is 263 points below the Covid-19-related peak of April 2020, it is trading 60 points above the CDS of Brazil and 143 points below the CDS of Turkey.
By definition, the rating downgrade to junk means that holders of South African sovereign debt must include a higher risk premium in the asset class valuation to reflect higher future risk of default, Packirisamy said. .
“However, international precedent has shown that downgrading within the non-investment grade group has less of an impact on sovereign performance levels than downgrading from investment grade to junk status.”
This is because the latest move could have mandate implications for bondholders and thus trigger the forced sale., as such, the country’s exclusion from global bond indices after Moody’s downgraded it to junk status in March this year was of greater significance to returns, Packirisamy said.
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