Download Downgrade to junk – What does it mean? There has

Downgrade to junk – What does it mean?
There has been significant focus on South Africa’s credit rating, and the risk that it might be cut to junk status. This
has resulted in a lot of speculation about the ramifications on the Rand, as well as the implications on the South
African economy and political landscape.
What is ‘junk’ status?
Sovereign credit ratings give investors an insight into the risk
associated with investing in a particular country.
Just like a bank would assess your financial situation before
approving your loan application, investors look at a country’s
“balance sheet” when deciding whether to invest (or lend). To
help these investors, ratings agencies like S&P, Moodys and Fitch
give each country a credit rating after performing detailed
financial analysis.
The image on the right shows S&P’s credit rating scale. The rating
scale splits the credit ratings between ‘Investment grade’ and
‘Speculative’. Once a country is rated below BBB-, it’s risk is
deemed significant by the investment community, and this is
what the media is talking about when they say a country has been
cut to junk status.
Last year, S&P downgraded South Africa’s foreign currency
sovereign credit rating to BBB-.
Why is South Africa’s credit rating deteriorating?
It’s important to recognise that a number of factors which are putting pressure on South Africa’s credit rating are
outside it’s control. These are factors like low commodity prices and weakened demand from China - which have
dented output. However, factors that are within South Africa’s control have played a very significant part in the
deterioration.
The last few years have been marred by labour unrest and electricity supply uncertainty, which have impacted
economic growth. Many of South Africa’s state owned enterprises are also in disarray. This means that they are
undermining growth by virtue of the fact that they are costing money rather than adding value. The finance minister
debacle and the tenuous nature of Pravin Gordhan’s current position are also playing a very significant part. The
resulting depreciation of the Rand shows just how much emphasis investors place on fiscal discipline and consistent
economic policy.
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Impact of a cut to ‘junk’ status
A cut in a country’s sovereign rating to junk can be a significant event in the eyes of investors. For example, many
institutional investors have covenants which limit their ability to invest in junk or ‘non-investment grade’
instruments. A cut to junk could therefore reduce investment in South African bonds.
A cut to junk could also increase the cost of borrowing for both government and the private sector, which could
negatively impact corporate earnings and therefore equity prices. A sell-off of bonds and equities by international
investors could mean significant Rand depreciation.
Can South Africa emerge unscathed?
If S&P downgraded South Africa to junk, other rating agencies would have to follow suit for South Africa to be
considered Non-Investment grade.
Given that an ‘imminent’ cut to junk status is front-page news, and given that the Rand was one of the world’s worst
performing currencies in 2015 - an optimistic view would be that the market may have priced in a deterioration in
South Africa’s sovereign rating. However, it’s likely that the shock of a downgrade would still have a negative impact
on the currency.
Where we go from here depends heavily on the government’s ability to tackle crises in state owned enterprises,
electricity supply constraints, and most importantly – labour unrest and unemployment. It will be up to Pravin
Gordhan to ensure fiscal discipline and to re-assure the market that there won’t be any unexpected U-turns in
economic policy.
There is a big question mark on whether Gordhan can achieve this, or whether he will even be Finance Minister for
long enough to try - given that he is simultaneously fighting a political battle against captured state organs and
members of the president’s inner circle.
There is certainly a lot resting on his shoulders.
Kyle Sonderup CA (SA), CFA, B.Com (Hons), B.Com, DipFP
April 2016
Kyle is the head of MyGlobalCFO – trusted leaders in financial emigration and foreign exchange transfer. The above article is
provided for information purposes only. It is not financial advice, and is not intended to imply any recommendation or opinion
about a financial product.
MyGlobalCFO is a division of AQB Financial Services CC Reg No 2004/086901/23
Registered South African Financial Services Provider FSB Licence No. 6402
Registered office: AQB Heads View Old Toll Road Knysna 6571 PO Box 270 Knysna 6570 South Africa
Tel: +61(0)44 993 2643 +27(0)44 382 5150 [email protected] www.myglobalcfo.com