With GDP growth revised downward, SA markets brace for downgrade

The Central Bank on Thursday announced that the repo rate would remain unchanged at 7%. It also revised economic growth for the year downward to 0.6%, and inflation from 6.6 to 6.7%.

The gloomy economic climate has been exacerbated by policy uncertainty likely to influence the upcoming international credit ratings by Fitch and Standard & Poor’s.

Since his appointment, Finance Minister Pravin Gordhan has been intent on scattering the kind of breadcrumbs that might signal a policy-certain economic path. His efforts appeared to pay off earlier this month, with credit ratings agency Moody’s surprise decision to affirm South Africa’s Baa2 credit rating.

But, says RMB’s Chief Economist Ettienne Le Roux, “If [a downgrade] doesn’t happen in June it very likely will in December.”

Part of the impact of at least one of the agencies revising SA’s status downward has already been factored into the markets with a weakened rand and bond yields rising. But it will also mean “higher borrowing costs for the public sector, banks etc. which, in turn, will have serious real economy effects”.

Credit ratings (and expectations of shifts in ratings) determine how much a country pays for its debt. When a country is relegated to junk status, it means that there’s a risk that the government won’t be able to repay its bonds, so convincing investors to buy bonds requires high interest rates.

This is turn hurts economic performance, increasing the chance of the country in fact defaulting, and so on and so forth. Of course, the country can opt to cut spending targets, or borrow internally, but both alternatively ultimately knock the economy, as it means forfeiting spending as a tool for stimulating growth.

Being relegated to junk is like falling into a black hole. It takes an average of 7.5 years for a country to claw its way out, according to RMB research. In the global economic climate post the 2008 recession, the average sovereign credit rating around the world has fallen by about one notch. SA is ahead of the curve here, except not in a good way, having fallen by two, and our BRICS buddies Russia and Brazil are already in the junk category (as of February last year and this February respectively).

Ratings agencies consider a number of factors when making their decisions, says Roux. The obvious one is GDP growth patterns. SA has seen GDP growth drop from 4% in 2008 to its current estimate of just over 0.5%. (The dismal state of the economy was further highlighted this week with the release of the unemployment stats for the first quarter (26.7%) – the worst on record.)

Other factors are fiscal and monetary performance, balance of payment vulnerability and qualitative factors such as institutional and governance effectiveness. The latter reassures investors that the government is doing what it can to stem external economic shocks, make good on fiscal promises and ensure a business friendly environment. Ahead of the Moody’s review, Gordhan pointed out in March that SA had yet to default on its fiscal promises in 20 years of democracy.

“Much of what impedes growth [in SA] is domestic in nature,” Le Roux observes, which could really be seen as either good or bad news depending on how you look at it. “A few important factors are persistent skills constraints, lack of competitive pressures, often violent and lengthy strikes, policy uncertainty in key sectors dampening business sentiment etc.

“There is evidence some of these constraints are being addressed. This is arguably why Moody’s for example decided not to further downgrade the sovereign, at least for now,” he added.

Given the importance of the political climate, the Gupta scandals, parliamentary upheaval and, particularly, the Gordhan/Hawks battle are unfortunately timed – although the strength of our judicial system at least was recently affirmed by the Constitutional Court’s Nkandla ruling.

Referring to the rumours of a Gupta-orchestrated, Hawks-facilitated arrest of Gordhan that emerged last weekend, Le Roux offered a dash of comfort to those anxiously awaiting the credit rating agencies’ verdicts: “Typically, rating agencies will not act on rumours.” DM