Download South Africa in Crisis

South Africans are currently living through extraordinary times of political and economic upheaval.
The recent decision to replace a number of cabinet ministers, including the well-respected finance minister Pravin
Gordhan and his deputy, Mcebisi Jonas, while retaining those who have performed poorly, has caused immense
damage to the country’s reputation. The resultant loss of confidence has triggered massive market volatility, a
currency shock and investment outflows. Unfortunately, the first signs of an economic recovery, seen over recent
months, won’t survive this turmoil. Hopeful expectations of interest rate cuts later this year may be at risk.
The upheaval has culminated in the loss of South Africa’s foreign currency investment grade rating from Standard &
Poor’s. A country’s rating is the agency’s assessment of the government’s ability to meet its debt obligations in a timely
manner and this is a clear sign of significant deterioration. Our economy has benefited enormously from this rating
over the past 17 years, which has been undone 90 hours after the midnight-hour cabinet reshuffle. The repercussions
may be felt for years to come. We expect other ratings agencies to follow suit.
We are comfortable that our strategies can withstand the worst of the current volatility. Following ongoing, rigorous
stress-testing, we believe we have built robust portfolios that can handle these kinds of shocks. Our recent
performance is testament to this ability.
Yet the current crisis is extremely concerning to us. South Africa has been ripped apart by infighting, corruption and a
failure to deliver. As always, the situation holds the most serious consequences for the poor, who have no defence
against the subsequent economic fall-out: higher inflation and interest rates, and a shrinking job pool.
The country needs political commitment to boost confidence and recommit to the sound economic policy pursued by
prior ministers of finance. Current policy indications look to deviate from that. Our expectations are of further ratings
downgrades, which could happen in quick succession.
Impact on Coronation’s strategies
Recent shocks, both abroad and in SA, have proved that the best protection against an uncertain future is investing in
a diversified portfolio of undervalued assets. The aim with our multi-asset funds is to build anti-fragile strategies that
can withstand unexpected developments. When we manage portfolios, we look at total exposure to major risk events –
including sharp movements in currencies, inflation and interest rates.
Our multi-asset portfolios have remained at close to maximum offshore exposure levels for the past number of years,
and within our local equity holdings we have a high representation of companies which earn the majority of their
earnings offshore. We have consistently had very little exposure to domestic government bonds as we have felt the
pricing was not sufficiently attractive relative to other asset classes. We continue to invest only in assets and
instruments that we believe have the correct risk and term premium, to limit investor downside and maximise return.
Times of stress and great emotion in markets often present opportunities to the unemotive long-term investor.
However, we continue to remain very cautious and mindful of a deterioration in domestic fiscal discipline. We believe
that as it stands, current valuations do not compensate for the negative fundamental backdrop and uncertainties in
South Africa, as well as the potential for a very different set of fiscal strategies, already pronounced on by the new
finance minister. Especially concerning is the signalled commitment to an imprudent nuclear energy programme, as
reaffirmed earlier today. In addition, another loss at the Treasury, the now outgoing director-general Lungisa Fuzile,
will create a material gap in credibility at the institution.
What lies ahead for South Africa
History suggests that it takes much longer to regain a lost investment grade rating than to lose it. Only a minority of
countries that have lost their investment rating over recent decades have succeeded in gaining it back.
South Africa's investment grade rating was achieved following many years of hard discipline and tough decisions by
the ANC government. After inheriting a dysfunctional and over-indebted economy, the first democratic government
reined in spending, recapitalised the state pension fund (which had been plundered), and created a transparent longterm budgeting process which anchored fiscal policy to a sustainable path. A new constitution helped provide the
framework for economic and legal institutions, and a commitment to growing, entrenching and protecting these
institutions helped restore confidence and steered the economy onto a better growth path and a fiscally strong position.
Over time, ratings agencies acknowledged the progress and upgraded their sovereign ratings for South Africa, with
Moody’s awarding an investment grade status in 1998, and S&P following later in 1999. This helped lower the cost of
borrowing and enabled the state to provide basic services and welfare grants to the poor and to reduce its debt.
These achievements have now been undermined. In recent years, there has been considerable fiscal slippage,
exacerbated by poorly managed state-owned enterprises. Low growth and deteriorating confidence have in turn
contributed to weak employment growth (outside of the state), low private sector investment and growing inequality.
Looking ahead, there are a number of ongoing risks. The first is that ratings downgrades do not tend to happen in
isolation – the factors that prompt a downgrade, especially below investment grade, tend to have taken time to develop
and carry some momentum, while sufficient remedial action can take years to implement. Secondly, South Africa’s
inclusion in the Citi World Government Bond Index (WGBI) – which is a considerable boon for domestic funding – is
contingent on two agencies holding the country’s local currency rating above investment grade. At this stage, both S&P
and Fitch hold these ratings on the cusp. While this suggests risk is still a little way off, things can deteriorate very
quickly.
Our fear is that as the economy deteriorates and unemployment rises due to the effects of the decisions taken, there
will be rising discontent from the majority of the population affected. This will likely result in greater levels of civil unrest
and increased populist rhetoric and actions from government, which will engender further loss of confidence in South
Africa.
History has taught us that our ability to forecast the immediate future is limited. As always, our focus is on building
diversified portfolios of undervalued assets that can withstand shocks, such as those we are currently experiencing.
Coronation’s first priority is ensuring that your investment will withstand the worst of the volatility. Over the past 24
years, we have provided our clients with investment excellence through many volatile and uncertain times. This time is
no different.