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What the Moody’s downgrade means for South Africa

by Salaamedia

Written by Abdullah Shaikh

“Rating agency Moody’s cuts South Africa’s credit rating to junk” was the headline that gripped South Africans a few days back. Moody’s, the last to rate the country as investment grade, finally downgraded the credit rating of South Africa to Ba1 (with a negative outlook), in line with economists’ expectations. This could not have come at the worst time, with the country deep in recession, struggling to minimize its government debt, and amidst a global pandemic.

What is a credit rating and why is it so important?

A sovereign credit rating is an assessment of how likely it is for the government (the borrower) to default on its obligations. Sovereign credit ratings are especially important since national governments are the largest issuers of bonds on the international capital market. These ratings serve as indicators to international investors, who would prefer to invest in rated bonds, rather than unrated bonds, of similar credit risk. These ratings also influence the cost of borrowing.

The rationale behind the downgrade

Moody’s asserts that South Africa’s structurally very weak economic growth was, amongst other reasons, the main cause of the downgrade. Despite the efforts of the South African Reserve Bank (SARB) to cut the repo rate by 100 basis points (equivalent to 1 percentage point), Moody’s believes that South Africa’s fiscal and monetary policy is highly ineffective to generate economic growth. They also believe that the policies of the government will be ineffective to address structural problems.

Unreliable electricity supply by the state is a factor that restrains economic growth. Moody’s believes that the government has not yet implemented an effective strategy to address underlying electricity supply issues, and this will in all probability continue in the years to come before potential capacity can be achieved. Although the electricity supply may become stable in the future, economic growth rates will be persistently low.

Moody’s explains that “progress on structural economic reforms has been very limited”. Structural issues within the South African context, such as labour market rigidities causing persistently high unemployment rates, continue to minimize growth rates.

Uncertainties around the land reform (i.e., the land expropriation without compensation debacle) and low business and investor confidence further hinder growth rates.

Amidst all the economic turmoil, the unprecedented coronavirus outbreak will worsen the economic challenges facing South Africa and exacerbate the impact of low growth rates on the ailing economy.

A further reason for the downgrade, as cited by Moody’s, was the inexorable rise in government debt over the medium term. Moody’s believes that the debt burden will rise over the next 5 years, and it is estimated to be a whopping 91% of GDP in 2023. This can be attributed (but is not limited) to higher interest payments, expected weak nominal growth, a growing public sector wage bill, and continuing support and bail-outs to state-owned enterprises.

What does this mean for South Africa?

The biggest consequence of this sub-investment credit rating by Moody’s is that South African government bonds will be excluded from the major World Government Bond Index (WGBI), forcing asset managers to sell billions of rands’ worth of SA bonds.

This also has negative consequences on the ordinary South African:

  • The government would now have to spend more to service its debt, which means less government expenditure on essentials such as infrastructure, investments, and social initiatives.
  • A plausible way for the government to increase its revenue might be to impose higher taxes.
  • This will cause a major depreciation of the currency (this has a negative impact on the fuel price since imports like oil are more expensive).
  • This could cause an increase in inflation, which means a lower real-income.

With this in mind, there is no denying the negative impact of this on the economy and on our daily lives. This could, however, deteriorate further if the coronavirus pandemic persists and the South African government fails to address structural issues (i.e., remain unsuccessful in improving the fiscal health of the country) and steer us away from a recession.

Featured image from Google via Moneyweb. 

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