The dichotomy between the negative political and economic narrative in South Africa – precipitated by the March 30 Cabinet reshuffle and the subsequent ratings downgrades by S&P Global Ratings and Fitch Ratings – and the relatively sanguine response of currency, bond and equity markets has been somewhat perplexing.
True, in the immediate aftermath of President Jacob Zuma’s late-night executive overhaul, the rand declined materially. However, at the time of writing, the currency was demonstrating relative resilience and the yields on South African bonds had not deteriorated markedly.
Does this mean that sovereign ratings are not as significant as has been pontificated? The simple answer is, no. Credit ratings matter, especially for a country such as South Africa, which relies, to borrow a phrase from Bank of England governor Mark Carney, on the “kind- ness of strangers” to finance its fiscal and current account deficits. That largesse is now significant, with foreigners owning about 35% of government’s rand-denominated debt of around R1.7-trillion.
It should not be overlooked that only Fitch Ratings downgraded South Africa’s rand-denominated debt to ‘junk’, with S&P having sustained an investment-grade rating on rand-denominated debt, albeit with a negative outlook. Moody’s, which has placed South Africa on review, is yet to make a call, but currently assigns an investment-grade rating to both foreign and rand debt.
However, should two of the three ratings agencies move to junk our rand-denominated debt, the fallout will be significant. Such downgrades will result in South African bonds being excluded from certain bond indexes, stopping purchases by those index tracker funds whose mandates preclude bonds below an investment-grade threshold.
So, if ratings matter and the current market reaction may simply be the calm before the storm, can South Africa avoid the worst? Here the answer is more complex, but much depends on the reaction of government to the downgrades.
One economist who has given the current “dichotomy” much thought is Investment Solutions chief economist Lesiba Mothata. Speaking at Wits Business School recently, Mothata sketched a “fallen angel bond” scenario – a bond that remains attractive to some investors, despite having sunk into a subinvestment grade, or junk. He argued that South Africa did not share the characteristics of other countries (South Korea, Hungary and Colombia), where the market reaction to downgrades had been more adverse. “Our issues are not exogenous . . . And that suggests that we are a good prospect of being a fallen angel and can turn this thing around if we do the right things.”
But what are the right things? Here the answer is relatively straightforward. South Africa has to pick up from where former Finance Minister Pravin Gordhan left off. Firstly, recognise the importance of sustaining an investment-grade rating. Secondly, hold the fiscal consolidation line. Thirdly, rebuild broken relations with business and labour. And lastly, do far more to rebuild business and investor confidence, because, without private investment, South Africa’s unacceptably weak growth outlook will be sustained, despite improvement in the external environment. Can Zuma’s post-purge executive deliver? Well, that is the R1.7-trillion question.