SA dodges downgrade for now

Last week ended with a welcome sigh of relief with Standard & Poor’s (S&P), one of the major global rating agencies, announcing its decision not to downgrade South Africa’s credit rating to junk status.

In the time leading up to this announcement, Treasury and the Finance minister put their best foot forward in an attempt to show S&P that improvements were in progress. Frequent talks and discussions with government and the private sector were held to determine how to tackle the problems highlighted by the rating agencies as hindering the economy. Although it might seem that their work has paid off, there is a big caveat.

As many market experts had predicted, even though S&P did not downgrade South Africa to junk status on Friday, it is widely expected do so in December this year. So whilst there is a welcome reprieve, more work remains to be done.

Credit rating

One need only look at the steady decline in South Africa’s rating over the last few years to see how much still needs to be done.

As it stands, the three main rating agencies (S&P, Fitch and Moody’s) have all assigned South Africa’s rating as ‘investment grade’ – though only just. Incidentally Fitch is expected to announce its view on South Africa’s credit rating this week.

Furthermore, market outlooks are generally negative, attesting to the structural problems within the economy which need to be addressed, otherwise a downgrade will materialise.

Markets

Prior to Friday’s announcement, the bond markets had mostly priced in a downgrade. This was due to an increase in bond yields. As assets are deemed riskier, investors require a higher return in order to invest in these riskier assets and therefore their yields increase.

Another statistic to monitor is the country credit default swap (“CDS”) spread. This measures what the market demands to be paid to insure a country’s debt. South Africa’s CDS spread has increased over the past months as the markets expected a downgrade. Our CDS spread is currently in line with some countries which are not investment grade, meaning that market has mostly priced in a downgrade. These increased bond yields and CDS spreads have been seen in other countries (for example Brazil) that have gone on to be downgraded to junk status.

The way forward

Although there is no downgrade for now, the market believes this can and will still happen due to a number of structural problems that still need to be addressed, including:

  • minimal expected economic growth (the economy is only expected to grow by less than 1% over 2016, down from 1.3% in 2015);
  • high levels of unemployment (currently around 26%)
  • tensions in the labour markets;
  • political strains etc.

All of these factors have contributed to the weakening rand and increasing inflation. In turn, this reduces the consumers’ spending power which is key to improving economic growth.

Anxiety in the markets is therefore expected to continue, manifesting itself through continued weakening in the rand and volatility in equity and bond markets. If the rating agencies are left unconvinced we will most likely see a downgrade to junk status later this year.

If you have any questions on the above, please do contact us at Novare.