While ratings agencies have indicated that changes in economic policies and practices could reverse the country's downgrade to junk status, research organisation Trade and Industrial Strategies (Tips) found that these policy demands on South Africa were “contradictory”.
In a policy brief published on April 8, the organisation suggested rather, that “a downgrade was almost unavoidable” as growth slowed with global metals prices, although policy errors, especially around electricity and large-scale corruption, had aggravated the problem.
In this context, the ratings agencies’ policy analysis and recommendations ignore the fundamental structural challenges resulting from mining dependency combined with the deep inequalities and high joblessness left by Apartheid.
It explained that the downgrade pointed to the need for economic policy to incorporate a more sophisticated and consistent understanding of business perceptions. From the standpoint of government, a core function of economic policy is to manage business to meet social aims while remaining economically sustainable. That requires a better understanding of the different factions within business, which often have divergent interests.
In the case of the downgrade, however, Tips mentioned that significant gaps had emerged between importers and the financial sector, on the one hand, and exporters and local producers on the other. “A challenge in this context is that the financial sector’s highly developed lobbying capacity often drowns out the voices of other business groupings.”
The organisation suggest that, to improve its credit rating, South Africa must reduce worker protections, limit land reform and cut government spending. However, Tips on April 8 said these measures would all, in turn, aggravate social inequalities and policy contestation, increase investor uncertainty and risks over the long run.
Tips’ findings follow after ratings agency Moody’s joined Fitch and S&P's to downgrade South Africa’s sovereign rating to below investment grade, which is also known as 'junk' status. This means that all three of the dominant international ratings agencies see any investment in South Africa as relatively risky.
However, Tips indicated that, in practice, the impacts of the global economic crisis owing to the Covid-19 pandemic would “swamp the outcomes” of the downgrade. Although it mentioned that it was worth understanding the likely effects, which varied for different economic sectors and stakeholders, to ensure a reasoned response.
In this context, Tips noted that it was “particularly important” to evaluate the policy recommendations incorporated into the justification for the downgrade.
An analysis of the impacts and justification for the downgrade led to Tips concluding that the downgrade’s main direct impact was to accelerate the outflow of the financial investments, in turn, leading to downward pressure on the rand, higher interest rates for international borrowing and even lower share prices.
Tips said these effects were not very visible, adding that this was because of the Covid-19 crisis having already led to a massive capital outflow and depreciation. As such, the organization found that South Africa is “particularly vulnerable” to changes in global financial flows, because it saw a disproportionate amount of large foreign purchases of company shares and government bonds from 1994.
A consequence of this, it explained, was that South Africa’s public and private foreign debt rose from near zero in 1994 to above the average for upper-middle income economies, excluding China.
Additionally, Tips indicated that some producers would gain and others would lose from the downgrade, the associated depreciation, and higher costs for international borrowing.
However, the main losers were financial institutions, if international financial transactions shrink.
Importers of both consumer and intermediate goods could also lose, it warned, since the rand price of foreign products would rise with depreciation. In addition, the National Treasury would end up paying higher interest rates, which was a particularly hard burden given rising deficits.
On the other hand, however, Tips said exporters and local producers that compete with imports should gain, as depreciation makes their products more competitive with foreign suppliers. Local producers of commodities such as iron-ore, chicken, wheat and maize, whose prices in South Africa track international dollar-denominated markets, also stand to benefit from this.
Purchasers of these products will, however, bear the higher costs.
Further, in practice, Tips said the Covid-19 pandemic had overshadowed the effects of the downgrade. By the end of March, the pandemic had already fuelled a massive capital outflow and higher debt costs, offset somewhat by a spike in the gold price; sharply reduced the international cost of crude oil, which is South Africa’s single largest import; and dampened demand for exports and imports irrespective of the exchange rate.
The lockdown from late March will lead to a significant fall in the gross domestic product (GDP) since most producers would have had to shut down for at least three weeks, Tips lamented.
It explained, however, that the ratings agencies justified the downgrade as the consequence of slow growth, and that the agencies blame the sluggish GDP principally on policy failures combined with unusually deep economic and social inequalities, and the resulting conflicts over policy.
Tips believes this analysis ignores the “overwhelming” impact of the sharp decline in global mining prices from 2011, which led to a steep drop-off in export earnings and in the process dragged down GDP growth.
In practice, Tips found that the actual effects had been drowned out by the global Covid-19 crisis and that the world’s GDP likely fell sharply in March, although data was not yet available. In March, prices fell for virtually all South Africa’s major exports except gold. The Covid-19 crisis also led to a huge outflow of funds from emerging markets into investments seen as less risky, especially US bonds.
As a result, many developing economies, especially if they depend on mining or petroleum exports, saw a sharp depreciation against the dollar from early March through early April. However, on the brighter side, the price of petrol dropped from over $60/bl in early March to under $25/bl by the end of the month.
Since petrol is South Africa’s largest single foreign purchase, the decline partially offset the effects of depreciation on South Africa’s import bill.
In conclusion, Tips noted that the economic effects of the recent credit ratings downgrade had been overtaken by the Covid-19 crisis; the implications of which, for financial investment, were “trivial” compared with the massive outflow of foreign capital that began in early March, as the devastating effects of the pandemic in the US and Europe emerged.
As such, Tips believes the policy recommendations associated with the downgrade need to be tested in terms of their relevance to national needs and priorities as well as the evidence. Above all, the organisation stated that the downgrades downplay the main roots of slow growth in recent times and instead focus on proposals that could aggravate social and economic tension and conflict, especially by rolling back worker rights and limiting land reform efforts.
Tips believes these measures will aggravate inequality and policy conflict.
It said this “would ultimately harm growth” and “ignore the core challenge of diversifying away from dependence on commodity exports, which only brings prosperity when global prices are high”.
Finally, the organisation stated that the downgrade highlighted South Africa’s unusually heavy dependence on foreign purchases of shares and bonds. That dependency has benefited the financial sector and importers and has enabled rising foreign borrowing by government, but it “has arguably made it harder for local producers to compete both in South Africa and abroad”.
In the process, it had contributed to continued dependence on mining exports and the result has been continued vulnerability both to international metal prices cycles and to rapid fluctuations in international financial flows, Tips said.