South Africa has recently been downgraded to Junk Status by the S&P Ratings agent.  Lungile Malinga, Equity Research Analyst, speaks to The HardHat Economist on what the implications of this downgrade means to the Construction industry.

What is the Junk Status?

Rating agencies rate a number of country’s local and foreign currency debt. When a country’s debt is in Junk Status – It means that it not investment grade according to the rating agencies. Debt below investment grade (Junk) is riskier and therefore has higher interest rates applied to it by lenders locally and offshore.

 

Why was South Africa downgraded?

South Africa was downgraded for a number of reasons throughout the year, most recently SA was downgraded by S&P. S&P cut our local currency rating from BBB- with a negative outlook to BB+ with a stable outlook. Specifically, S&P said “economic decisions in recent years have largely focused on the distribution – rather than the growth of – national income. As a consequence, South Africa’s economy has stagnated and external competitiveness has eroded. We expect that offsetting fiscal measures will be proposed in the forthcoming 2018 budget in February next year, but these may be insufficient to stabilize public finances in the near term, contrary to our previous expectations.”

 

What is the role of Ratings agencies and why does their opinion matter?

The role of the rating agencies as similar to those of a credit bureau that conducts credit checks for individuals and gives them a credit score. When an individual applies for a loan, the bank would like to know what the individuals credit score looks like. If one has a good credit record and score, the bank is more likely to extend credit at favourable interest rates. The same applies for a country and its government. The rating agencies rate and score a country’s ability borrow and meet its credit payments as well its ability to take on more debt. Should their score be downgraded, they are perceived to be riskier and therefore get credit at higher interest rates.

Therefore, rating agencies help lenders understand who they are giving their money to and what risks lie with investing in that sovereign currency debt.

 

What are the implications to SA when we are classified as Junk Status?

The first and obvious implication is that it will be more expensive for SA to obtain debt. As we are perceived risker, our bond yields will have to rise with that in order to remain attractive to investors.  A downgrade in SA comes with higher borrowing costs meaning that government has to spend more on debt instalments, taking away from other places the money could’ve been used to service the economy, like spending on infrastructure and education, to name a few.

 

What are the implications to the ordinary person when we are classified as Junk Status?

While SA is currently facing a large budget deficit, the government could further increases taxes which would negatively affect the ordinary person.

The currency also tends to weaken when a country is downgraded, which affects the costs of imports and as a result feeds through into consumer inflation. Inflation and currency stability are the key mandates that the SARB operates by. Should the currency weaken significantly and inflation wonder outside of its 3%-6% target range, interests rates are likely to increase because of that.

 

What are the implications to the Construction Industry when we are classified as Junk Status?

As a result of the increased debt servicing costs in SA, this could take away from other areas of the economy as mentioned. Government spending on Infrastructure could be held back as the current fiscus is in deficit and cannot handle any more spending without further deteriorating SA’s credit rating.

 

Where to from here? How do we get out of this?

Currently, Moody’s (a ratings agency) left our rating unchanged but placed us on credit watch and will make a decision in 90 days, after the February budget speech. In order to avoid a Moody’s downgrade the agency said it would need to conclude that South Africa’s “policy response is likely to bring the economic, institutional and fiscal trends on a path so that these factors remain consistent with Baa3 peers; and that developments in the political economy offer the prospect of a more stable, growth-friendly institutional backdrop.”

 

And in order to get our ratings back at investment grade, the above needs to happen on a consistent basis to restore confidence in the South African economy.

 

 

 

 

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Lungile Malinga
Lungile graduated from UCT in 2014 with a BCom (Economics and Finance) and thereafter she joined Allan Gray on the graduate program. During her time at Allan Gray she fulfilled the role of operations consultant while simultaneously pursuing her honours degree in financial analysis and portfolio management from UCT. Lungile completed her honours and shortly after moved to IPREO where she firmed her career trajectory in the research field by becoming a Global Markets Intelligence Analyst. Lungile’s aspirations of joining the buy-side as a research analyst were realised when she joined the team at Effectus Capital Management in 2016. Lungile enjoys wine tasting and is an avid marathon runner.

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