3 April 2020
By Jeff Gable, Head of Research, Absa Group
South Africa’s sovereign credit rating was downgraded by Moody’s Investor Services on Friday evening. Thus for the first time since South Africa’s return to global markets in 1994 the country is no longer rated investment grade by any of the large global credit rating agencies. Moody’s, which now rates South Africa Ba1 (one notch below investment grade) and with negative outlook, joins Fitch Ratings and S&P Global Ratings, who also currently rate the country’s long-term local currency debt one notch below investment grade and with negative outlook.
With nuances at the margin, all three rating agencies remain concerned about the underlying weaknesses in South Africa’s economic growth and the political and social constraints that have made necessary structural reforms difficult to date, and the country’s deepening fiscal challenges and sharply deteriorating public debt outlook and consequent constraints on the state’s capacity to stimulate the economy. Furthermore, the unprecedented economic and social challenges presented both globally and domestically by the coronavirus pandemic are likely to further diminish South Africa’s credit worthiness.
South Africa’s credit rating has not only symbolic importance, but also is an important driver of the price of debt financing for the government curve and beyond. Markets have focused on the potential for a downgrade from Moody’s as South Africa deterioration to a speculative grade rating (or “junk” in common parlance) will trigger the exit of the government’s rand-denominated bonds from several major global bond indices, including the FTSE Russell World Global Bond Index (WGBI) and the World Inflation-linked Securities Index (WILSI). That exit is now expected to take place at the end of April, effective early May. Absa’s FIC Research team estimates that this is likely to trigger $4-8bn in forced selling from global funds that passively track these indices.
It wasn’t always this way, and from South Africa’s inaugural credit ratings in 1994, the country’s ratings had enjoyed an upwards trajectory through the 1990s and much of the 2000s. Over this period, the country’s economic growth had tended to strengthen, stronger public and private sector investment helped generate significant numbers of new jobs, public finance went from strength to strength and the public debt was shrunk considerably as a proportion of GDP, many state owned companies operated without government financial assistance and the country’s institutions were seen as strong. Fitch and S&P each upgraded the country’s credit rating four times during this period, and Moody’s awarded South African with 3 upgraded. Indeed, South Africa’s entry into these very same global bond indices in 2012 came as the country’s credit rating was at its peak.
The period that has followed has been less kind to South Africa’s perceived credit worthiness and the country’s credit rating has been on a downward trajectory since S&P first cut the country by one notch (to A) in January 2011. Further downgrades were delivered by all major credit agencies in the years since. Fitch was the first to cut South Africa’s credit rating to speculative grade in April 2017, followed by a similar move by S&P in November of the same year, and now Moody’s has followed suit.
It is tempting to ask the question, “how long does it take for a country to regain investment grade status?” Often answers are informed by looking to the experience of other Emerging Markets with a sort of average time figure being used. This misses the underlying point, however. South Africa’s credit rating has deteriorated because of very low (and currently negative) economic growth, large fiscal deficits and sharply rising public debt, loss-making state-owned entities, and deep contestation of proposed social and economic policy reforms. That all agencies currently hold the country’s credit rating under negative outlook suggests that they do not see significant improvement likely soon. And it will be that significant improvement, if delivered, that will ultimately determine whether South Africa will be able to plot of a difficult return to investment grade in the years ahead, move sideways at current levels, or slide further away from investment grade. The answers will be found here in South Africa, rather than by looking at the examples of other Emerging Markets and the specifics of their economies, policy choices and politics.
One final point that is important to remember in this difficult time is that credit rating agencies do not exist to lecture governments, to try to diminish the democratic process, or even to try to influence government policy. Rather their job is focused on helping investors understand the creditworthiness of an issuer. With that in mind, it is hard to argue that South Africa hasn’t witnessed a steep deterioration in fundamentals, in part by our own ability to act over the last decade and in part due to the new risks due to the global virus. And so it is the agencies’ duty to reflect that in their ratings. Similarly it is clear that it is up to South Africa, and not the credit rating agencies, as to which direction that country would like to take going forward.