How SA can avoid another notch slide to a “Junk” credit rating

The South African financial sector is painfully aware that the country's global credit rating is dangerously close to dropping to "Junk" status. In this insightful discussion, Futuregrowth's Wikus Furstenberg explains why there's been such a precipitous slide in recent years, and what is required to arrest and reverse the trend – before it's too late. – AH.ALEC HOGG: Wikus, wherever I talk to people in the South African environment nowadays the feeling is glum and it hasn't been helped by downgrades. Not too many people actually understand what these downgrades are, so perhaps you can very briefly tell us why ratings agencies are playing such a big part in our lives nowadays..WIKUS FURSTENBERG: Alec, yes, we don't always have a positive view on the international rating agencies but the point is they are important. I think, just broadly speaking, they help to align different groupings of countries together, in terms of risk. Using micro economic analysis, they will look at different ratios and try measure the risk of default by different groups of countries. That is why they would assign different ratings to different countries. In South Africa's case, as you probably know, there are three major international rating agencies that are looking at South Africa: S&P, Moody's, and then, also Fitch. Most recently, Moody's downgraded South Africa, I think, just for this. Maybe the purpose of this is probably it makes more sense to focus this on the one. Let's just focus on the big one, S&P, and their rating, at the moment for South Africa..The sovereign foreign currency rating for South Africa is sitting at a BBB minus, which it is at the bottom of the investment great, so another notch down, to the rating band of BB plus, means that South Africa will be seen as sub-investment grade. That does have implications for funding offshore and the costs of that funding. Obviously, the lower the rating the higher the risk on default, and obviously the higher the cost of that funding. So it does have a direct impact on, for instance, Government financing..ALEC HOGG: We are spending R100bn a year on interests on Government debt, so no doubt the rating, if you get a one percent or a two percent difference in the bottom line, is big..WIKUS FURSTENBERG: Most certainly and it is not just the Central Government. Keep in mind there's a close link between the sovereign ratings for the sovereign, the country, South Africa in this case, or Government for that matter. Then of course State owned enterprises, and even some corporates. You cannot expect State owned enterprise, for instance, to go into the international market and then borrow at cheaper rates than what would the National Government will be paying for it..ALEC HOGG: How big are the State-owned enterprises, in the international capital markets?.WIKUS FURSTENBERG: Alec, generally we are lucky in that sense that Government way back made I think a very good call to say 'listen, we want to manage our offshore debt exposure. We want to keep it relatively small'. If I remember correctly, at that point, the target was set at something like no more than seven percent. That is small and the reason for that is because we know what happened to countries, in particular those in South America who really relied a lot on international markets, to finance their budget deficits. At the end of the day things really turned pear shaped. These owned State-enterprises, obviously in South Africa's case, followed what happened to the National Government, in terms of setting those targets. Our offshore exposure isn't high but it will have an impact on local funding rates as well. It is not just, what happens in offshore markets..ALEC HOGG: So if S&P decided to downgrade South Africa to below investment grade, it is not just the seven percent – foreign debt – that will be affected?.WIKUS FURSTENBERG: It will be certainly foreign debt that will be affected but, to some extent, the local market will also be impacted and that's the more important market for the Government to tap into to fund their deficits. It is really very hard to have a view that if we see more downgrades that local rates will not go up. They will have to adjust, depending obviously, where they are at that point, when we see more downgrades. I think the important thing to note here is also that, according to National Treasury foreign investors hold about 37 percent of total, local, South African Government debt and partly because South Africa is some of those offshore indices and some of the offshore managers are tracking some of those indices as well. It will have implications. It is not something that one can ignore..ALEC HOGG: Why do these rating agencies downgrade a country, and let's look at South Africa in particular. Why have we had this trend?.WIKUS FURSTENBERG: Well, there's a number of reasons but maybe we should just stick two main reasons. It's about growth prospects that look particularly poor, not only on an absolute basis but also relative to other countries in the same rating band. If we say countries in the same rating band, here we have countries like Russia, Uruguay, India, Romania, and Brazil it also sits in the BBB minus credit band for S&P, like South Africa. It's about those growth prospects and the reason or reasons why that's poor, and South Africa's case, we know, and we've discussed this many times, and you in particular, the structural problems that we have, in South Africa..That makes it very difficult to be bullish on growth, going forward..We say bullish, we sort of hopefully and obviously we're referring to growth rates of five percent and higher. It is very difficult for South Africa to get to those. That's the one thing and obviously, that does have an impact. It does have an impact on the other things as well. The second thing is, is simply Government debt..In 2008, total Government debt, as a percent of GDP, was sitting in the mid-20 percent and is now on its way to 50 percent..Now, 50 percent isn't that high, when you compare that to many other countries, including developed markets. It is about the speed at which it is worsening and you get to a point, and people will call that many things. The word or the phrase that is thrown around a lot is the so-called debt-trap position, where you simply cannot afford to pay interest on your outstanding debt anymore. SA is not there yet, clearly not, but it is something that you will have to look at and these rating agencies, obviously will have to take a forward-looking view as well. In some instances where they say 'listen, there's a risk of this happening and as this unfolds your credit rating will drop'..ALEC HOGG: The big question, of course, is if you are moving in one direction, are there any signals that we can move out of it? In this case are there any signs that what needs to be done to reverse the declining credit ratings is actually happening?.WIKUS FURSTENBERG: I think, firstly, in terms of growth, Government is good at planning and putting together what needs to happen and, in particular how to boost growth or solving these structural issues. But it is about implementing those plans and we all know that we really battle to do that successfully, especially when it comes to these structural issues. It is not just about electricity shortages. It is also about the labour market. It is also about skills development and it is also about education and those things move very slowly. But all we can do, and Government can do, and obviously all of us, for that matter, we need to work on it and keep working on it..That's the one thing and I think, secondly, to get to Government finances, it is probably a little bit easier. The Finance Minister in October, said 'right, things sounds all okay'. Obviously, the proof is in the pudding. The first thing you need to sort out is to maintain that expenditure ceiling and ensure that you stabilise that budget deficit position and bring it closer to a three percent, as opposed to the four percent, where we are at the moment..ALEC HOGG: At least there is some hope, looking forward but those structural issues are. Perhaps we're going to require a little bit more political will?.WIKUS FURSTENBERG: That's the problem. Maybe things will move along a little bit better with all the fiscal pressure that's applied to Government, at the moment, from both sides. Clearly, if you stand back and again look at the big picture, things like your current account balance, your budget balance, and the GINI co-efficient is the other thing. Unemployment rates or total debt as a percent of GDP – it's important to keep an eye on those things and work it away, but as you said, Government realises that and National Treasury in particular. They are well aware of those issues and, behind the scenes, trying really hard. They know what to do to fix those things. But even if you have a National Treasury that knows what they're doing, you need the political will to enable National Treasury, from their side, to do what they have to do.

How SA can avoid another notch slide to a “Junk” credit rating

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