Moody’s Downgrade Announcement – Finally it Happens!
On Friday, the 27th of March, Moody’s rating agency downgraded South Africa’s credit rating to a level below investment grade, also known as “Junk”. Moody’s finally confirmed what we had spoken about and anticipated for close on two years.
Given that our government’s financial position has deteriorated over the past ten years, it is no surprise that Moody’s did downgrade us. Our government simply does not receive enough income from taxes (our GDP growth figure is too low) to enable it to spend efficiently on infrastructure and services. We have to borrow to pay for these annual expenses, and this level of borrowing has increased by nearly double in the last ten years.
What practically happens now that we are downgraded?
The practical effects of this type of downgrade are that global asset managers that manage money for individuals/corporates/government pensions/etc. could have rules about which level of credit rating they are allowed to invest in.
South Africa has been a popular destination for these asset managers over the past ten years to some degree, as we offer high-interest rate returns on government debt, often referred to as “yield”. Our exchange rate has depreciated against the major currencies. Still, despite this currency depreciation, the real return offered by government debt for global asset managers has been enticing enough for them to take the risk.
With Moody’s announcement on Friday, we expect that some global asset managers will now have to disinvest from South Africa in the bond market, as their investment rules do not allow them to invest in countries that do not hold an investment-grade rating. The flow of money out from South Africa has the potential to increase the interest rate that our government can offer for their bonds. This will directly impact the government’s debt repayments.
What is the short and medium-term consequence of the downgrade for South Africa?
Although some global asset managers will be taking money out of South Africa post this downgrade, many other asset managers are allowed to invest in South African bonds. As mentioned, this decision by Moody’s was widely expected by the investment community, and that has already reflected in the rate of interest offered by the South African government on their bonds. We can always expect an overreaction from the market in the short term, and this could result in the Rand weakening further against major currencies. Our interest rates payable on bonds could increase too, but this will come back down in time.
Brazil was downgraded into sub-investment grade in February 2016. South Africa’s economy is similar in terms of its structure (commodities dominant, unemployment rate, etc.) even though our population is much smaller.
After Brazil was graded as Junk, its stock market has increased by approximately 215% in the past four years. Their government bond yield was at 16.5% in February 2016, and it now sits at 7.8%. The downgrade forced the Brazilian government to make significant changes to their economy, and this resulted in the advantageous moves in the stock market and bond yields.
Of course, the big overlaying factor is the current COVID 19 pandemic, and the effect this will have on our economy and the world. We believe that it is better for this downgrade to have happened now rather than when the world returns to a new normal. We can now focus on changing the economic landscape that our country so desperately needs.