Fools in April

President’s faux pas means the worst kind of April Fools for South Africa Inc, reports Gareth Stokes At the end of March 2017, South Africa’s President Jacob Zuma announced a wholesale Cabinet restructure that affected no fewer than ten ministerial and ten deputy ministerial posts. Pravin Gordhan and Mcebisi Jonas, the minister and deputy minister of finance, were summarily dumped despite being credited with supervising one of the country’s most capable ministries. Thus began an ‘April for fools’, as the country learned the hard way that playing musical chairs with important Cabinet positions has dire consequences. Ratings agency Standard & Poor’s rerated South Africa’s local currency debt to one notch above junk (BBB-) and its minority foreign-currency debt to junk status (BB) on 3 April. Fitch followed a few days later when it decided, on 7 April, to downgrade the country’s foreign currency and local currency ratings by one notch. Moody’s took a wait and see approach and kept South Africa’s investment grade at two levels above junk with a negative outlook, warning that the rating was under imminent review for a downgrade. “This is bad news for all South Africans and businesses,” says Viviene Pearson‚ CEO at the South African Insurance Association (SAIA). She adds that the downgrade is something the country could ill afford at a time when the economy was growing at the slowest pace since the 2009 recession – and with official unemployment at 27%. SAIA, the representative body for South Africa’s short-term insurers, warns that the credit downgrade will have far-reaching consequences. Ailing rand The currency was the first to stumble under junk status. The rand, among the most volatile currencies in the world, suffered major setbacks as each stage of the process unfolded. From a consumer perspective, the immediate effect of the credit downgrade will be felt at the fuel pumps (with a larger than anticipated spike in the price of diesel and petrol in May) and a sharp rise in the cost of imported goods such as new cars. Insurers have warned that consumers will have to cough up more for their general insurance too; as monthly premiums go up to accommodate currency weakness. WesBank, South Africa’s largest vehicle finance provider, says the country’s economic hardships will be felt by motorists who have existing credit agreements as well as those looking to purchase new vehicles. “The economic downgrade is like a poor credit record – it means that it will become more expensive for South Africa to borrow money from international banks and investors,” says Rudolf Mahoney, head of brand and communications at WesBank. But supporters of Mr Zuma’s liberal interference – the African National Congress has largely come out in support of the shenanigans, with the few dissenting voices soon changing their tune – will argue that the rand, currently at ZAR13.30 against the US dollar, is stronger than its average ZAR14.70 against the US dollar for 2016. Economists have also conceded that every 10% slide against the dollar only adds 0.7% to the inflation basket. The only solace for Mr Zuma’s detractors being to wonder how much further the rand could have strengthened from its peak of ZAR12.40 against the US dollar in late March. And thus the currency concern quickly dissolves into a whimsical ‘what could have been’. The bond market appears to have ridden out the storm too. According to Patrice Rassou, head of equities at Sanlam Investment Management, South Africa is still rated investment grade on its local currency debt, with the result that bonds will not be sold. He adds that the country’s five-year dollar credit default swap was already priced at the same level as Brazil (at 225bps) and similarly to Russia and Croatia, which are also rated BB. “On a relative basis, South Africa debt was already priced for the downgrade,” he says. South Africa’s large insurers were soon tarred with the same downgrade brush; but the move appears largely academic. “Santam would be able to withstand the stress associated with a default by South Africa on its foreign currency obligations, based on its asset base and supported by its credible and executable risk-mitigation plan,” noted S&P. “These strengths indicate that the insurer is unlikely to default on its insurance liabilities under a sovereign default, if one were to occur…” But they downgraded the insurer anyway. Santam’s response was little more than a ‘shrug’ via a SENS announcement stating that the rating adjustments were not expected to negatively affect its solvency position and that it had adequate capital to stay solvent in the face of rising risks. Its response was echoed by other insurers that suffered similar fates. What’s the problem? If bond markets, the currency, inflation and insurers are largely unaffected, what exactly is the problem with junk status? Setting aside the ‘what could have been’, which is of course immeasurable, the short answer would be that South Africa’s reputation as a suitable destination for foreign capital has been torn to shreds. Without fresh capital, ordinary citizens will bear the brunt of a downgraded economy as both GDP growth and job opportunities disappear. And small business will flounder under the triple whammy of weaker currency, higher inflation and difficulties in attracting capital. Research analyst Nomura has already slashed South Africa’s economic growth forecast from 1.1% to 0.2% for 2017. Businesses and consumers will have to watch helplessly as their savings – whether held in pension funds or other discretionary investments – decline in real value. “South African banks lost R60bn in the initial hours following the 30 March cabinet reshuffle; but that is nothing compared to what the country stands to lose if the government does not respond appropriately to the ratings agency decisions,” says Mr Rassou. Of major concern is that S&P has retained a negative outlook on South Africa, despite its decision to downgrade. That could mean that worse news is still to follow. “How policymakers respond to the downgrade is going to be crucial,” says Mr Rassou. “If South Africa is to regain investment grade status, tough decisions are needed; faster fiscal consolidation is imperative and the budget needs to be more resilient, which means expenditure must be more aligned with revenue growth.” The current economic disaster is no different to the catastrophes we see play out in the real world. Just as it takes time to clean up after a Tsunami, so too is there no quick fix for the damage done to international investor confidence. Mr Rassou concludes that South Africa will have to go into debt counselling for a number of years. “National Treasury will now have a fine financial tightrope to walk, balancing the fiscal restraint necessary to keep our foreign creditors at bay while fulfilling the mandate of poverty alleviation,” he says. His sentiment is echoed by Ms. Pearson, who concludes: “What South Africa needs is macroeconomic stability and policy certainty‚ which supports sustainable inclusive economic growth”.

Fools in April

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