The most important thing about a downgrade

“Is how a country responds.

Patrick Cairns   |  25 July 2016 00:37 

CAPE TOWN – While last month’s decisions by S&P and Fitch not to downgrade South Africa’s credit rating were met with a lot of relief in the markets, the threat is far from past. In December the country will once again face decisions from the two ratings agencies, and there is still a high chance that a downgrade will be announced.

However, speaking at the recent CoreShares ETF Exchange conference, the MD of S&P Ratings Services Konrad Reuss, said that it is important for South Africa to adopt the right approach when dealing with the possibility of a downgrade.

“A downgrade would obviously be a major event, but it doesn’t have to be a disruptive event,” he said. “If South Africa was to lose its investment grade, the question really becomes what are the responses.”

He pointed out that S&P rates around 130 sovereign governments around the world, and since the mid-1970s it has downgraded 21 of them from investment grade to sub-investment grade status. Of those, only seven have so far managed to recover their investment grade rating.

“Once you’ve dropped out, you do not immediately return,” Reuss said. “A recent example is Brazil. Just a few years ago it was everything to everybody, but it dropped out of investment grade, has dropped another two notches since then and continues to have a negative outlook.”

The lesson from this is that if a country does not heed the warnings inherent in a downgrade and continues to do the same things, the picture will continue to deteriorate. What is needed is concerted and concentrated action.

“You need to push the reset button on your policies,” said Reuss. “You must look at what has gone wrong, why has the downgrade happened, and why has your fiscal picture deteriorated. You need to react quickly.”

Economist at Investment Solutions, Lesiba Mothatha said that what is encouraging is that there are already signs that this is happening. Led by Finance Minister Pravin Gordhan, South Africa is responding.

“The threat of a downgrade has galvanised a lot of conversation, and that has been very positive,” he said. “When you listen to the conversations coming out of National Treasury, the language is interesting. There is more focus on SMMEs (small-, medium- and micro-enterprises) with talk about a venture capital-type SMME fund. There is a micro-economic focus in the response, which I think should be the answer to how we get out of this.”

Reuss acknowledged that the fact that government is reaching out to the private sector is a big positive factor.

“We haven’t had that before,” he said. “Usually one blames the other. Now, for the first time, there is a constructive effort to get it right.”

Speaking at a Liberty media luncheon last week, Stanlib emerging market economist Kganya Kgare agreed that this developing partnership, led by Minister Gordhan, has been very encouraging.

“What’s good about Minister Gordhan is that he’s been one of the most engaging finance ministers, even compared to his former self,” Kgare said. “He engages a lot with the private sector and ratings agencies, and that might save us. Is there more that could be done? Yes. However at this point, there are good signs.”

Economist Mike Schüssler said that in facing up to a downgrade, there has to be some new thinking in how South Africa addresses it current economic issues.

“From a policy perspective, maybe a downgrade will be the best thing that every happened because it will change policy,” he said. “We should be focusing on how we find employment for those people who don’t have a job. And the biggest unemployment levels are in the rural areas.”

He suggested that there should be more effective initiatives around farming and food production, but the country should also explore ways to encourage businesses to set up operations in places where there are already sizeable populations.

“Everything we do is concentrated around the big cities, but we should also look at how we can get development in certain areas where people are already converging like Bushbuckridge or Thohoyandou,” Schüssler said. “If someone who is already living in one of those areas has to go all the way to Nelspruit or Polokwane to find work, he has to get a second home and there are big transport costs involved. If we lowered the cost of finding work, that might make a big difference.”

Mothatha suggested that another way of stimulating development away from the major centres could be to look at mining towns that have been deeply hurt by the slump in commodity prices.

“Imagine creating economic zones around these battered towns to attract SMMEs,” he said. “There is already infrastructure there, and if you lower taxes and create the right conditions they could be turned into havens for those running small businesses.””

Leave a Reply