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South Africa lives with the existential threat of a ratings downgrade

Brian Browdie

South Africa has an unhealthy concern with losing its investment-grade credit rating.

Or at least it appeared that way last week after Moody’s Investors Service gave the government three months to show progress in its strategy to halt the deterioration of its finances or face a cut in its creditworthiness to junk status.

The move, which Moody’s foreshadowed by lowering its outlook on South Africa’s rating to negative from stable, triggered a freak-out in the financial community—at least that’s how local media told the story.

Headlines declared South Africa had escaped the “junk guillotine” and warned of the country’s “last chance” to avoid a downgrade. “It’s a stay of execution,” said a portfolio manager. One investment strategist termed the country’s fiscal situation “a car crash in slow motion.” “It’s now or never,” warned South Africa’s finance minister.

But for all the hand-wringing, South Africans themselves stand to see little change in their daily lives from a downgrade by Moody’s, according to economists.

“Bottom line is, I don’t think there will be a huge impact on ordinary South Africans,” says Johann Els, chief economist at Old Mutual Investment Group. “The actual downgrade itself isn’t a big deal. To a very large extent it’s been priced into the markets.”

A junk rating from Moody’s also could bring with it a silver lining. “Maybe reforms will be instituted that will be good for the economy down the line, which in the medium to longer term are good for ordinary South Africans because they will be good for growth,” adds Els, based on his belief that the government would strive to maintain at least one investment-grade rating following both S&P and Fitch lowering their ratings on South African debt to junk in 2017.

To be sure, South Africa faces a series of fiscal challenges, with economic growth forecast to be 0.5% for 2019, a weak employment outlook (including an unemployment rate of 29%), and government debt projected to grow to 71% of gross domestic product by 2022 (up from 57% at the end of 2018).

Bailouts of financially distressed state-owned companies, particularly the power utility Eskom, make up the fastest-growing share of public spending. “We are facing a slow-burn economic crisis,” the finance minister wrote in the foreword to the government’s draft economic plan two days before Moody’s issued its assessment.

A loss of the remaining investment-grade rating would disqualify South African bonds from inclusion in world government bond indexes; the selloff by institutional investors that ensued would cause an estimated $15 billion to flow out of South African debt. But an uptick in yields in the wake of a downgrade (which would lift the cost of borrowing) likely would cause other investors to come in.

While investment-grade remains the best option, both Moody’s and Els note that South Africa, for all its fiscal woes, remains an attractive investment destination.

The country’s “deep, stable financial sector, resilience to a prolonged period of low growth, and a robust macroeconomic policy framework” all influenced Moody’s decision to affirm its investment-grade rating for now, the ratings agency said.

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