Economy faces harder recovery path following Moody’s downgrade, says business

30th March 2020 By: Marleny Arnoldi - Creamer Media Online Writer

Economy faces harder recovery path following Moody’s downgrade, says business

Photo by: Bloomberg

Business organisation Business Leadership South Africa (BLSA) says Moody’s downgrade of South Africa’s debt rating to junk status will significantly impact the way the economy is defended through the Covid-19 crisis.

The ratings agency on March 27 downgraded South Africa’s sovereign credit rating to junk status, despite industry calls for the decision to be postponed until after the Covid-19 pandemic passes in South Africa, since it has frustrated economic reform efforts.

Moody’s downgraded the country’s long-term foreign currency and local currency issuer ratings to Ba1 from Baa3, with a negative outlook. The Ba1 rating implied a significant credit risk.

Financial institution Citadel chief economist Maarten Ackerman says the rating downgrade came as no surprise, since South Africa’s fiscal metrics had been unsustainable for some time.

“If the global outlook had not deteriorated so significantly, there might have been a chance that Moody’s would still have acknowledged the reform-minded government’s potential to set the economy right. However, this was not to be and Moody’s hands were effectively tied,” he highlights.

The National Treasury points out that the sovereign downgrade will further add to the prevailing financial market stress. These two events will truly test South African financial markets.

“South Africa’s deep, stable financial sector and robust macroeconomic policy framework had always been flagged as a credit strength, including the South African Reserve Bank’s demonstration of a good track record in implementing credible and effective monetary policy and preserving financial stability.

“However, the sovereign downgrade would see South Africa being excluded from the World Government Bond Index and the government bond market would experience further capital outflows – as fund managers with investment grade mandates would be forced to sell South African government bonds,” Treasury says.

Nonresidents held about 37%, or R800-billion, of the total domestic government bonds and the number is expected to substantially decline with the combined impact of Covid-19 and the downgrade.

The interest rate for government, households and the broader economy is also expected to increase as a result. While some market participants argue that the impact of a sovereign downgrade has already been priced in, it is difficult to stipulate with certainty the extent.

“Therefore, to say we are not concerned and trembling in our boots about what might be in the coming weeks and months is an understatement,” Finance Minister Tito Mboweni said.

BLSA explains that the Covid-19 crisis was not directly relevant to Moody’s decision, though it complicated the situation, exacerbating the challenge of rebuilding an economy capable of regaining investment grade in the future.

“South Africa gained investment grade 21 years ago after hard work by government to put the country’s finances on sound footing. We had lost it owing to mismanagement and corruption through the years of Jacob Zuma’s Presidency, which allowed debt levels to balloon massively, making ratings agencies doubt the country’s creditworthiness, while undermining key oversight institutions,” BLSA notes.

The organisation adds that South Africa’s creditworthiness was further lost because of negative per capita economic growth for the last five years, which has constrained tax collection and employment.

BLSA believes the most prominent issue that has remained from the prior Presidency period was capable leadership at Eskom, allowing a further round of independent power producer procurement and allowing self-generation by companies. 

In its decision motivation, Moody’s cited labour market reform that had not been delivered, as well as easier obtaining of visas for foreigners, outstanding mining regulations and an outstanding regulatory environment that was conducive for oil and gas development.

Financial consultancy Intellidex says Moody’s is likely to cut South Africa’s ratings again in the next year, while ratings agencies Standard & Poor’s and Fitch are also likely to both downgrade South Africa further in coming months.

“We see virtually zero probability that South Africa would regain investment-grade status in the next three years.

“There would now be a massive battle to be waged between the National Treasury showing us hopefully what they are made of on the one hand and the rest of government thinking the shackles are now off.”

In light of Covid-19, the Moody’s downgrade and the state of the economy prior to these events, Investec says South Africa’s gross domestic product is likely to contract by 2.7% this year, especially owing to worsening government finances as resources are being directed to mitigate the impacts of Covid-19.

The asset management company says South Africa is at risk of another credit rating downgrade, potentially before the end of the year. Further credit rating downgrades to South Africa’s sovereign debt will further weaken financial market indicators, negatively impacting on the growth and socioeconomic outlook.

Standard Bank South Africa CE Lungisa Fuzile says South Africa’s economic and fiscal challenges will be exacerbated by the deteriorating global economic outlook and the next few months will indeed be a very challenging time for every South African.

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BLSA acknowledges that it was necessary for President Cyril Ramaphosa to declare a state of emergency, since it enabled him access to more resources and the ability to implement regulations more rapidly.

This while employers needed access to payroll support to avoid needing to lay off idle workers as a result of the subsequently declared lockdown.

The organisation adds that companies need access to bridging finance either through the banking system or some other mechanism, so as to avert business rescue proceedings.

Intellidex says the National Treasury must move with speed to re-establish credibility.

“An emergency budget at the end of April, after the lockdown, is crucial. The budget should lay out, transparently, what is going on with growth, the revenue impact of Covid-19 and the implications for the fiscal framework and issuance. This would ensure Treasury kept decent access to market for issuance into a hugely challenging second quarter,” the consultancy states.

Business organisation Business Unity South Africa (Busa) says now is not the time for pointing fingers or starting blame games.

The country needs to rather concentrate all its resources and capacity on beating the virus before the country ends up in a worse position economically.

Busa stresses the need for structural changes in the economy, less public sector expenditure, less wastage of resources on insolvent State-owned enterprises, doing away with legislation that erodes investor confidence and for government to provide cohesive messages.

Treasury, meanwhile, assures that the South African Reserve Bank is already working on measures to stabilise financial markets, while government is working on structural economic reforms.

Ackerman notes that for investors with a longer-term horizon, this presents an opportunity to lock in higher yields. In the longer term, the bond market should perform well, given the higher interest rates that they were able to access, while inflation was still quite muted.

“What we do know is that, in time, this will pass. And even if there is more pain to come in the near term, there will definitely be more upside over the longer term,” he says.

Mboweni shares Ackerman’s positive outlook.

“The opportunity we had was to unite and work together to address our challenges. We had overcome insurmountable challenges in the past and we could still overcome.”