There has been much debate around what the Rand will do once ratings agencies confirm their views on South Africa’s credit market. We hope to explain how the ratings agencies and national politics affect the local currency and the economy.
Who are the ratings agencies?
Before we dive into the possible outcomes of a ratings downgrade, it’s best that you understand the functions of the different ratings agencies and what their views mean for the South African economy.
The three agencies in question, arranged from largest to smallest, are: Standard & Poor’s (S&P), Moody’s Investor Service and Fitch Ratings. In 2012, it was reported that the three agencies together accounted for approximately 96% of all credit ratings. This extremely high market share has come under scrutiny in recent years due to the high barrier of entry it creates in the credit ratings industry, but that’s a topic for another day.
Below you will find a graph that shows our historical ratings performance. As you can see, since the 2008/2009 financial crisis, it’s been a bit of a bumpy ride. The left and right axes denote the two different (but equal) ratings systems the three agencies use.
As it stands South Africa is bordering on “junk” status for both S&P and Fitch and is one notch above that for Moody’s. Each ratings agency provides a ratings outlook and whilst notches don’t always change, the outlooks themselves have the ability to startle a market. As you can see, we find ourselves in a rather complicated scenario with both mixed outlooks and ratings. Of the three agencies, none seem to agree on the correct overall view on South Africa’s credit rating, which results in the numerous permutations.
Both S&P and Moody’s have confirmed that they will make their announcement in June regarding their ratings outlook. South African’s will wait with bated breath until then as the outcomes could spell disaster for financial markets in the Republic.
What happens when a country is downgraded to junk?
Ultimately, this means that our government debt (bonds) lose their coveted “investment grade” status. The first real effect of this is that many global bond indices will remove South African bonds from their tracking. This, then, prompts global investors, both institutional and individual, to sell South African bonds in order to align their individual portfolios with their chosen index.
For example, South Africa is currently included in the Bloomberg USD Investment Grade Emerging Market Bond Index and the Citigroup World Government Bond Index. Should both S&P and Moody’s downgrade South Africa, we could find ourselves falling off these indexes. In addition to this, many Global pension funds are prohibited from investing in “junk” debt. All this will result in an increase in the outflow of money from South Africa, and considering our quarterly outflows have exceeded inflows for the last 16 quarters, things are not looking great.
In short, after a downgrade there will be a marked and negative effect on the economy. However, analysts agree that this will likely be a short term effect on the Rand. Several analysts convincingly argue that a downgrade has already been priced into both the Rand and local bond yields. So any further medium- to long-term deterioration should not be related to the downgrade specifically, but more the unsettled economic and political landscape South Africa is facing; which brings us to our next talking point.
How do national politics affect the Rand?
In a word: hugely. Historically, South Africa’s politics have made front pages globally and this always seems to influence the Rand. More recently, our politics have come under scrutiny since Jacob Zuma’s shock replacing of Finance Minister Nhlanhla Nene with David van Rooyen, followed by the latter’s replacement by Pravin Gordhan just four days later in December last year. In the space of five days, South Africa went through three finance ministers. As a result of “Nene-gate” our political and financial institutions were severely questioned by international and local investors. This negative sentiment, born purely out of national politics, spooked markets and the Rand plummeted.
On the other hand, on the 31st of March the Constitutional Court ruled against President Zuma. Finding that he had failed to uphold the Constitution of South Africa. The ruling was related to the President’s failure to pay back a portion of the money spent on upgrading his private home in Nkandla. This decision was seen as a victory for the democratic institutions of South Africa and the currency strengthened quite clearly on this day.
|Political event||Total Rand deviation||Event Volatility*|
|Finance Minister reshuffle||GBP/ZAR dev.: R3.97c||18%|
|Constitutional court ruling||GBP/ZAR dev.: R0.94c||4.3%|
The event volatility is taken as the total deviation divided by the base rand price*
Based on the above, we can see the total event volatilities sit at 18% and 4.3% respectively. These figures may not mean much when viewed in isolation but when you consider the fact that over the past year daily average volatility deviation sits at 0.069%, these political events then appear to create some serious data outliers.
The Rand and local politics: Hand in hand, for better or worse
The reality is that now more than ever, political events will for the foreseeable future, dictate the Rand’s performance. This will be all the more so in the months to come, with this year’s municipal elections due to be held this August.
Ratings agencies have stated that governance, political reform and the implementation of prudent economic policy will all be factored into their respective decisions.
Unfortunately, long-winded court battles and political controversies continue to make front page reports. Ultimately, these sideshows have the potential to drag down our currency and distract the world from the progress we, as a democracy, are hoping to make economically, politically and socially.
Please note the above piece serves as opinion and should by no means be received as advice.