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SA’s recent credit rating driven potentially by the COVID-19 impact

11 May 2020 The Institute of Risk Management South Africa

The credit rating industry is usually only three major world players; the Moody's, Standard & Poor's (S&P) and Fitch, all originating from the United States. Credit ratings are a measure of the creditworthiness of a country’s government, meaning that they show how likely the government is able to service its debt. The credit 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 that high risk. So the three credit rating agencies mentioned above do not measure the health of the local economy, but 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.

Below are the factors that affect the credit rating:

1. Political stability;
2. Level of national debt;
3. Debt interest payments as a percentage of Gross Domestic Product (GDP);
4. Lastly the economic growth.

Prior to the COVID-19 outbreak, SA was rated BBB- with a negative outlook [1]. This meant that the South Africa’s sovereign debt was still seen as investment grade, while also signifying that a downgrade was likely. So, this was already a signal to potential investors that the risk of SA’s debt has increased because government might not have enough money to pay back what it borrows.

Then this negative signal was exacerbated by the recent downgrade of SA’s rating from the above mentioned (BAA3) rating to (BA1), also known as junk status. Any cut in ratings to "junk" category means a country is not a place that investors could look at for investments and this cripples the government's ability to raise money, especially from overseas markets. In other words, it means that South African government bonds would ordinarily be removed from the World Government Bond Index (WGBI) and could have an impact of as much as $11 billion.

This junk status has come at a worst time for SA, as the country is battling with the COVID-19 pandemic. This has led to a lockdown which has negatively impacted the entire SA business community. Businesses/corporates in SA will perform very poorly financially, leading to very thin margins and potential losses. This will mean that businesses cannot even go to the financial markets to raise funds to sustain their businesses, their liquidity positions will be crippled and they will default in their current debt, such as interest payments on corporate bonds or any debt raised in the financial markets. This makes it worse for the country to borrow funds for sustainability in times like this and also raises a question for me on whether credit ratings makes sense where there are force majeure [2] events such as COVID-19.

Currently in SA, the economic growth is below 1% and the SA economy in 2019 grew only by a margin (0.2%) and predictions are that the impact of the COVID-19 is likely to sink the SA economy by 6%, this means the country has entered a technical recession. The irony is that Covid-19 has forced SA to implement some of the structural reforms that might have saved it from a downgrade but it’s rather too late. The South African Reserve Bank (SARB) stepped into the secondary bond market to purchase government bonds with newly created money, to increase money supply, this is called quantitative easing. This is done to encourage lending and investment is a country experiencing a recession. If the SARB were to just print more money to increase money supply, this would lead to inflation.

A number of directives and notices have been issued by institutions that a key in business community such as Companies and Intellectual Property Commission (CIPC), which has declared the COVID-19 outbreak as a disaster event. CIPC has provided relief for companies in SA that could be in breach on section 22 [3] of the Companies Act to be allowed to continue trade even if they are seen as trading recklessly due to COVID-19 impact. Regulators such as the SARB have also provided some notices and directives to banks, as the major players in retail banking with relief in some capital standards, liquidity standards, IFRS 9 compliance on accounting for credit losses as well as calculations on Non-Performing Loans. All this is done within the ombuds of the business law. The COVID-19 impact, such as, the rise of SA’s borrowing costs and government bonds, increased capital outflows, further weakening of the of the rand \ dollar exchange rate; at this point is projected and could be worse in three month time.

As risk practitioners, one should reflect the effects the credit rating has on:

1. Credit risk – considering that credit risk and default risk are very much interrelated. The former talks to the risk that the borrowers will not be able to service their loans and the latter is the risk that for instance in financial markets, where companies borrow funds through issuing corporate bonds, the bonds will not be redeemed when they mature or interest will not be paid when it’s due by the bond issuer.

2. Economic conditions in SA – considering the current economic conditions in SA, the COVID-19 outbreak and the junk status of the country, and the lenders have to consider restructuring their credit exposures, i.e. banks that are currently offering “payment holidays” to their customers, in order to provide relief to certain borrowers in the retail sector in an effort to mitigate the impact of the pandemic.

3. The financial regulators – that `are considering implementing measures to provide suitable temporary relief on the minimum capital requirements for banks relating to credit risk. This however does not mean that consumers have to continue taking on debt they cannot afford. SA community is already highly indebted because people borrow to consume, and are living beyond their means, leading to severe indebtedness. Government can also take this time to implement programmes to address the lack of financial literary and educate people on dangers of living beyond their means. SA is one of the top countries in the world that contains highly indebted poor communities. This is also exacerbated by the introduction of informal lenders such as Mashonisas, that provide credit without any sound credit policies and procedures. People in SA are in desperate need of financial literacy and it is a responsibility of government to address this.

4. Consideration of risk indicators such as,

• High debt to GDP levels
• An economy in recession
• Widening budget deficits and a weaker currency trend against the mainstream currencies – the US dollar, the British Pound and the Euro.
• The local currency has weakened by approximately 25% since January this year, having traded at R 14.01 to the US$ on the 31stDecember 2019 to trading at R 17.57 by close of business on 27 March 2020.

Leona Dukada – Associate at the South African Reserve Bank
(This article has been written on personal capacity and not as a voice of SARB)

[1] Negative outlook indicates that the ratings might be downgraded, while positive outlook means that the ratings may be upgraded.
[2] Force majeure is a serious unavoidable event that causes serious damage and is unforeseeable such as COVID-19 pandemic.
[3] Section 22 prohibits reckless trading

Quick Polls

QUESTION

The South African authorities are hard at work to ensure the country is removed from the global Financial Action Task Force grey-list by February or June 2025. What do you think about their ongoing efforts?

ANSWER

But what about the BRICS?
Compliance burden remains, grey-list or not.
End-2025 exit is too optimistic.
Grey-list is the new normal.
Too little, too late.
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