After many close calls, it’s finally happened. South Africa’s sovereign credit rating has been downgraded to junk status by Standard and Poor’s. Most of us know that this is a bad thing with serious consequences but not why. In this, the first of a two-part series, we look at what junk status means and how it will affect ordinary South Africans. Later, in the second part – distributed through the Old Mutual Money Mailer – we’ll look at what you can do to prepare for rising interest rates and inflation.
Credit ratings are a measure of the creditworthiness of a country’s government, meaning that they show how likely the government is to pay back borrowed money. These ratings are important because they influence the cost of borrowing. If a country is more likely to default, lenders will charge a higher interest rate to compensate for the greater risk, as they would if the borrower were an individual.
So, to be clear, the three credit rating agencies – Standard and Poor’s, Moody’s, and Fitch – do not measure the health of the local economy. Rather, they assess the government’s ability to honor debt commitments. These measurements take certain economic indicators into account and are themselves seen as indications of a country’s economic prospects.
Some of the factors affecting a country’s credit rating include political stability, level of national debt, debt maturity, debt interest payments as a percentage of GDP, and growth. By themselves, these factors wouldn’t serve as harbingers of economic doom, but when they’re given context, they can give economists, like those at the credit rating agencies, a more or less accurate picture of a country’s fiscal future.
In South Africa’s case, it was political turmoil, instability in the mining sector, slow economic growth, and the devaluating rand that brought us to the edge of the precipice, but it was Thursday night’s cabinet reshuffle that pushed us over the brink. After the announcement of Pravin Gordhan’s sacking, it took Standard and Poor’s only three days to downgrade South Africa’s credit rating.
Up until Monday, Standard & Poor’s rated South Africa as BBB- with a negative outlook. This marked South Africa’s sovereign debt as investment grade, while also signifying that a downgrade was likely. We have since been downgraded to BB+, which is commonly referred to as ‘non-investment grade speculative’ or ‘junk status’.
This rating signals to potential investors that the risk of South Africa’s debt has increased because the government might not have enough money to pay back what it borrows. Besides scaring off some investors, such a move also makes it very likely that the other credit rating agencies Fitch and Moody’s will downgrade their ratings for South Africa, exacerbating the problem.
With the downgrade, the government has to pay more in debt servicing costs, meaning that it will have less to spend on social initiatives and infrastructure. In order to plug the funding gap, government will have to increase revenue through higher taxes. But the effects of junk status don’t end at borrowing.
A downgrade would likely also cause the rand to depreciate which would make imports like oil more expensive. This makes everything else more expensive. When inflation rises above a designated target range, the South African Reserve Bank puts the repo rate up, which increases the cost of vehicle loans, mortgages, and other long term loans.
When lenders such as banks see a greater risk in borrowers defaulting, they increase premiums to compensate for the greater perceived risk. So, South Africans will also find it harder to qualify for new loans, and when they do secure credit, it will be more expensive, meaning that loans will be less of an option when finances are stretched.
There’s no denying that we face difficult times ahead. To survive amid higher inflation and rocketing interest rates, everyone will have to make changes. To learn what you can do to make the most of these “interesting” times, sign up for the Old Mutual Money Mailer. In this free monthly newsletter, we serve up practical advice on topics ranging from how to save for university to how to improve your credit score. With such information and a litttle self disclipline, it's possible to thrive everyone while else is just trying to keep their heads above water.