“Junk Status” – How does this affect you?
So lately, many people have been asking me how exactly we will be worse off as South Africans due to the recent rating downgrade to “junk status”. As a banker – and someone in credit risk myself, I have struggled to verbally simply this in person. So here is my best attempt at breaking this down in layman’s terms – I hope it isn’t too technical and you don’t switch off.
Firstly – I personally don’t like the term “junk status” it implies…well, exactly that – junk! I prefer “speculative grade” or “sub-investment grade” which is the PC term given to double B buckets (BB) beginning one notch down from the investment grade status (triple B buckets i.e. BBBs) – which South Africa enjoyed for the first time post democracy in 1995. These ratings are generally performed by 3 rating agencies – S&P (Standard & Poor’s), Moody’s and Fitch. These agencies basically assess the creditworthiness of companies and sovereigns (governments) – the same way a bank would look at your application for vehicle finance or a mortgage bond to determine your credit score – basically, they determine how “risky” you are, or rather, they assess the likelihood of you not making those payments on the loans you are applying for.
Now, I think it’s important to provide context here – each rating agency (although using similar methodology) analyses various factors to determine what a company or government’s credit rating is, these factors include a mix of the past history of borrowing and repaying its debts, as well as the future financial/economic potential and social and political factors. Also, the analysis of a rating is not performed overnight but usually over a period of time as all factors need to be considered in detail.
I am not going to bore you with the different types of ratings (long term vs short term, local currency vs foreign currency ratings), their meaning and what they measure – you can read that up if you wish. My focus in this piece, is merely to share what the possible impact of our recent downgrade will be to you and I – the man on the street.
Given the recent downgrade by S&P and Fitch – here is the cycle that my economic knowledge claims ensues:
Many investors (by their mandate/policy) such as pension funds and assets managers which invest in our government bonds (sovereign debt), are now not allowed to invest in them due to the speculative status of our sovereign
But here is an interesting fact – to date, Citibank analysts cited that foreign investors have purchased more than R20 billion in government bonds since Gordhan was axed. Not all bad news – huh?!
Getting back to point one – if investors now sell off their speculative grade bonds as they are no longer allowed to keep them – this causes what we call bond yields to increase as the guys who invested in these bonds (or who want to buy them) now require an increased return for the fact that they are now seen as riskier i.e. “speculative grade”. This is called market perception. Investors want to be rewarded for taking on more risk and as such – the yield (return) must increase to compensate for the increased risk.
Generally – in order to combat this, the Reserve Bank raises its interest rates in order to encourage investment i.e. higher interest rates means a higher return to the investor requiring it due to the speculative grade of South Africa. Higher interest rates means a more expensive car and house for you.
This rating downgrade also affects the banks, neighbouring trade countries and many other companies as all banks cannot be rated higher than their sovereign, therefore making the capital that a bank has to hold a higher amount. This ultimately affects the pricing of money borrowed in the entire economy. But mind you – bankers have generally already priced this rating downgrade into their capital base – South Africa truly has one of the best banking systems in the world J with most of our banks being well capitalised.
If our GDP growth remains stagnant or decreases, basically if our economy does not grow but we now have higher interest bills on debt as a country then either tax needs to increase to compensate for that higher interest bill or inflation (the general increase in the price of food, goods and services) will take its course.
While the cost of living is increasing by inflation, many of our salaries are not. Even worse – the unemployed in South Africa will experience the rise in the cost of living the most.
So basically – we need to tighten our belts. Our income will not go as far as it used to.
Although it is evident that our economy took some of the worst hits under Zuma’s rule, I would like to point out to you that there are many “first world” countries that have experienced worse. I refer you to the likes of Portugal, Italy, Ireland, Greece and Spain only recently (known as the PIIGS), or better yet – the great recession or credit crunch that started in the US in 2007/8 (Google these if you don’t know the details)
I have always admired Americans for one trait: they are the most patriotic people ever! They love their country and generally only focus on its positives – and you don’t even have to live there long enough to realise that they have a whole lot of Sh*t too!! So in this challenging economic period I advise you to believe in the potential of SA and do your bit for the economy. We can complain all we want about the ANC leadership – the fact is, unless some miracle takes place – I don’t see Zuma stepping down. And please don’t get me wrong – I hate to be political, but I firmly believe in the vision of Freedom Charter that the ANC put together in 1955, I simply detest how some of its leaders have disregarded this, pursued their own gains and have neglected the masses, the people of South Africa. There is no better time than now for us to stand together as a nation, we need the positive morale :)