Azar Jammine: S&P switch to “negative” a red flag for SA interest rates

Friday's report from ratings agency S&P switched its outlook on South Africa from "neutral" to "negative" – signalling another credit downgrade is on that cards. That would take the country's sovereign debt rating to three notches below the all-important Investment Grade level. Most analysts are focusing on another of the Big Three ratings agencies Moody's whose analysts still have SA debt at Investment Grade. But that's a mistake, says respected economist Azar Jammine, who in an interview on Rational Radio this week warned about the consequences. As there is a correlation between lower ratings and higher interest rates – and regardless of what Moody's decides, if S&P were to downgrade SA once again, it would have a major impact on the overall cost of servicing the country's debt. Jammine says a rabbit is desperately needed to be pulled from SA's hat… – Alec Hogg.A warm welcome to Dr Azar Jammine chief economist at Econometrix, I know you've been on holiday, but you always follow these things closely. On Friday, the S&P's report came out on South Africa's rating, it's been viewed in quite a negative light by most people in the country what's your thoughts on what you read?.___STEADY_PAYWALL___.There's no doubt that it does reflect the parlous fiscal situation that South Africa's government finds itself in. Having said that, I think the announcement of the downward revision of the outlook on the credit rating by S&P – following on from a similar corresponding downgrade three weeks ago by Moody's – came as no real surprise. There's been general recognition regarding the difficult fiscal situation that we find ourselves in and the real shock was the upward revision of budget deficits and the trajectory of the public debt to GDP ratios – incorporated into the medium term budget policy statement – at the end of October..Just to stop there a little bit, that really caught everybody by surprise – or so it seemed – that Tito was a) so outspoken and b) that the numbers looked so bad..Yes indeed. Conspiracy theorists will say the Treasury has been very open about the extent to which the fiscal situation has deteriorated. Some of the graphs that were incorporated into the document – that accompany the MTBPS – were quite shocking and you ask yourself why did they actually paint such a negative picture? Is it that they want to put pressure on government? Some might even say that they probably colluded indirectly with the ratings agencies to ensure that they created an environment in which government felt under pressure to actually respond to the introduction of measures – incorporated into the strategy document – that Treasury had tabled a couple of months earlier, to try to rectify..The thing that's worrying me – and I guess most South Africans – is we can see that there's problems, we know that we're moving in the wrong direction, why has nothing been done about it i.e. higher taxes or reduction in spending by the state?.Higher taxes, Tito mentioned in his medium term budget policy statement that he's reluctant to raise taxes too much because the Treasury has found that we seem to have gone beyond the threshold – at which higher taxes actually bring more revenue – and in fact higher tax rates could actually reduce revenue. The so-called Laffer effect. On the expenditure side there are two facets here. The first is state-owned enterprises and we can see the tremendous problems that SAA are facing right now and we know that Eskom has been under tremendous pressure as well. It involves government saving the day – if it wants to keep these as publicly owned companies – saving the day by using taxpayers money to bail them out and that increases government spending deficits and the debt. The second aspect that has been seemingly intractable, is people were hoping that the MTBPS would show some restraint on government public sector remuneration. And yet, if you analyse the figures, the ratio of compensation of employees to total government spending is set to remain unchanged over the next three years. There's very little sign of them cutting back on that. Part of it is due to the fact that they're tied in to a public sector wage agreement with public sector unions. Even beyond that, there seems to be a reluctance to contemplate anything below an inflation plus type of increase for public servants..Looks like we're heading for quite a bash there. But it's certainly – if one recalls in the budget – Tito did bring out his idea or his innovative thought, that he'd make it more appealing for public servants to go on pension. That doesn't seem to have worked. He said – I was in the lockup in the press conference – (the MTBPS) they're going to try again and this time they're going to market it better to the public servants. If that doesn't work and they can't raise taxes, what's next..On the state and State Owned Enterprise side, there is one other option and that is to sell off strategic stakes in these organisations and get new management – who is accountable to new private sector share holders – and therefore is obliged to act in a more profitable and competent manner than is the case when you've got government as a shareholder who, with the interpretation that government has endless resources to bail things out. As far as public sector remuneration is concerned, unfortunately the government will be headed for a confrontation between government and the trade unions. The irony of this is that the trade unions were at the heart of the support for Cyril Ramaphosa to become president as opposed to Nkosazana Dlamini Zuma – in the presidential election of the ANC – held at the end of 2017..Do you read anything from what happened in the last week with South African Airways?.What I really hear is that government tried to give the impression of actually negotiating with the unions and actually giving them a bit of leeway and almost giving some benefit to the unions. But if you think a little more deeply, if SAA goes bankrupt, then the agreement with the unions is meaningless to begin with. But at least it gave the unions a feeling that they've won this negotiation but actually if it ends in SAA closing down – which there's a very strong possibility of that – then clearly people will lose jobs..Azar, just getting back to the ratings agencies, we know that there is only one of the three big rating agencies that have given South Africa an investment grade – that's Moody's – their outlook is negative, which would suggest that when they do the next rating they're going to cut us to junk as well. Is that your reading of it?.Yes, that is my reading of it. But I want to warn against complacency regarding the S&P downward revision, because with S&P, one can say now that we run a negative outlook, that unless government pulls a rabbit out of the hat – in the February budget – that S&P likewise will cut our credit rating further into junk status. There is the view that since Moody's is the one that's investment grade and would go into junk – that is a much more serious downgrade – but one shouldn't overplay that. The danger with going deeper and deeper into junk status – which seems to be the case now potentially with S&P – is that there is a correlation between long term interest rates and the level of junk status, such that long term interest rates tend to accelerate in an upward direction the deeper into junk status one goes. So from a longer term point of view, if S&P downgrade us deeper into junk, government will be obliged to offer higher and higher interest rates on its bonds to keep attracting buyers. Already we know that debt servicing costs are set to rise by 2.5% of government spending over the next three years crowding out. In other words there'll be 2.5% less to spend on everything else (because of that 2.5% increase on interest payments) so a further sharp increase in long term interest rates obliging government to sell government bonds at those exorbitant levels, is going to exacerbate this crunch..So pull a rabbit out of the hat quickly please. Is that the question, is that what everyone should be praying for?.Logic says that the political machinations within the ANC won't allow that but you just never know. Funnily enough, markets could react very favourably to it – even if unions jump up and down and start protesting etc. – the markets might see this as a crunch point beyond much as what happened in the 70's in the UK which was the turning point in the fortunes of the UK economy..Azar Jammine, the chief economist of Econometrix.

Azar Jammine: S&P switch to “negative” a red flag for SA interest rates

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