Is junk status befitting a South Africa?

By Rafiq Raji, PhD

I have being doing a lot of reading about the 2007-08 global financial crisis (GFC) lately. And a recurring theme is how significantly culpable ratings agencies were for the crisis. Geoff Colvin of Fortune magazine wrote of ratings agencies on 22 December 2008: “clueless, conflicted and unregulated.” Okay, so maybe they got carried away with those American mortgages – until the bubble burst, almost everyone attended the party. And Mr Colvin’s stinging rebuke can be excused considering the recession in tandem with the GFC was still biting hard at the time. However, the fundamental question that I can’t get out of my head is: even after that abysmal failure, did ratings agencies really learn anything? Some recent credit rating decisions have been a little bit curious. Moody’s decision to affirm its two-notch above junk credit rating (Baa2) for South Africa in early May especially. In this regard, a South African columnist, Bronwyn Nortje, aptly titled her 12 May 2016 piece: “Be brave and tell us we are junk.” Of Moody’s she says further: “they are not brave enough to call a spade a spade and be the first ones to break the bad news that we’re junk.” I agree. As an African and one who loves South Africa – it is a beautiful country and the people are quite kind, I do worry about the additional hardships ordinary South Africans would grapple with if their country’s credit rating is downgraded to junk status by any of the major rating agencies. But as an analyst, being sentimental is a luxury I cannot afford. At this moment, South Africa’s credit is not investment grade. The authorities know it. Analysts know it. And so do the ratings agencies – Standard & Poor’s (S&P) and Fitch publish their reviews on 3 June and 8 June respectively.

Apart from the fact that growth is expected at about half of a percent this year and could be lower – the South African Reserve Bank only recently cut its forecast to 0.6 percent, the vulnerabilities of South Africa’s institutions have been exposed by President Jacob Zuma’s less than ideal approach to governance. Mr Zuma has demonstrated a mastery of these vulnerabilities. And it is increasingly likely he may serve his full second and final term as president – despite his beleaguered and scandal-ridden stewardship thus far. Much of the hesitation on the part of ratings agencies it seems to me is because of the goodwill of finance minister Pravin Gordhan. Such is the goodwill he enjoys that only last week, an influential South African business newspaper made an appeal to S&P to give the country a six-month breather. Considering how much stress Mr Gordhan has been under from the government he supposedly serves – from police investigations to a rumoured but officially debunked plan to arrest him for espionage, market participants dearly want him to succeed. Mr Gordhan’s troubles may not go away regardless. If South Africa’s sovereign credit rating is downgraded to a junk grade either by Fitch or S&P, Mr Gordhan would not have served Mr Zuma’s purpose. Conversely, if South Africa gets a reprieve, Mr Gordhan becomes a little bit more powerful than Mr Zuma would like. In the latter case, the embattled finance minister gets to leave – with Mr Zuma’s unsurprising resilience, it is increasingly likely he would – when the ovation is loudest at least.

In any case, on South Africa, ratings agencies have almost always followed the lead of market participants. In December 2015 – when Fitch downgraded the country’s rating by one notch to its lowest investment category (BBB-) and S&P changed the outlook on its own BBB- rating to negative, markets had priced in that view long before. The downgrades were simply a formality. Now, a similar trend is palpable. Credit default swap (CDS) spreads for South African credit are edging closer to that of Brazil’s – which all three major ratings agencies have in junk territory: First by S&P (the most hawkish) in September 2015, then Fitch in December 2015 and finally Moody’s in February 2016. Typically, ratings agencies tend to be quiet in the few weeks before a major decision. Thus, Fitch’s hawkish tone just a week before the announcement of its decision suggests to me it plans to affirm its current rating – not that it should. S&P has been somewhat consistent in its views on what it thinks of the South African economy. It would surprise me a great deal if S&P’s hard talk turns out to be huff and puff. Never mind that South African business leaders – keen to keep the newfound power a boxed-in Mr Zuma has had to cede to them – are desirous of demonstrating the extent of their influence. In any case, they could always point to Moody’s reprieve in the event of an adverse outcome from S&P and Fitch. More fundamentally, is junk status befitting a South Africa at this time? Yes. Growth is tepid and structural weaknesses abound. Political uncertainties make solving these problems harder. The part of me that loves South Africa and its people would gladly be wrong about my expectation of a likely downgrade to junk status by S&P this week. Tough love suggests to me, however, that maybe South Africa’s leaders need to be shocked into preventing further deterioration in their country’s fortunes. A rating downgrade to junk status may very well be the push that they need.

Also published in my BusinessDay newspaper back-page column. See link viz.

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