There are three main credit
rating agencies – Moody’s,
Standard & Poor’s, and Fitch. The agencies independently evaluate
and publish research on all bonds issued by corporations and governments.
The agencies have a long market history. Moody’s Investor Services was founded in 1909, Standard & Poor’s in 1860, and Fitch’s in 1914. All three agencies are based in the US.
What is a South African government bond?
A South African government
bond is an investment based on the country’s debt. Investors, local or
international, can buy bonds through the JSE, as retail bonds or unit trusts etc.
Almost 40% of investors are foreign.
And by investing in
these bonds, investors loan government money to fund public sector projects
(roads, power stations, schools, hospitals, etc).
The rating agencies assess the creditworthiness of a country’s government bonds and assign each country an investment grade. The higher the risk it sees in the bond or debt, the higher the interest rate the investor or lender will be able to charge.
What does a ratings agency downgrade mean?
If a ratings agency
downgrades a country to a sub-investment or non-investment status, this is a signal
to investors that the risk of that country’s debt has increased. In short, it means that the government may not
have enough money to pay back what it has borrowed.
A ‘non-investment grade speculative’ is called ‘junk status’ in investment shorthand. Keep in mind, a ratings agency usually waits 18 months before changing an investment status to give the relevant stakeholders time to address their concerns and amend policies. In South Africa, the main stakeholder would be the SA Reserve Bank.
In addition to their investment grade, a ratings agency can also publish what they think the future looks like for a country’s debt. The outlook can be negative or positive.
The FTSE World Government Bond Index lists and measures the performance of government bonds from around the world. If a bond falls to junk status, the WGBI will often force or compel certain investors to sell their holdings in government bonds or debts.
How did South Africa end up at junk status?
We experienced the
first major downgrade in 2012. There are a few things that sent us into a
spiral. Broadly, these were slow economic growth and a weak GDP,
political instability, turmoil in the mining sector and an overburdened Eskom.
It may take South Africa years to recover and regain a more favourable investment-grade status from investment agencies. However, it is important to view a downgrade in the context of other economic, social and global events – the Coronavirus (Covid-19) pandemic is one example, a change in corporate or personal taxes is another.
If we look outside our
own situation, Brazil experienced economic growth after it was downgraded to
junk status in 2015. We can all recognise that the world and markets are
unpredictable – so that is always something to keep in mind. While South
Africa may not feature in the investment-grade bonds, it may be appealing for
investors in sub-grade bonds.
When a country is stripped of an investment grade, the cost of capital is almost sure to rise, but the important thing is for the country’s economy to remain resilient and aim for improvement.
How long does it take to recover from a downgrade?
South Africa’s downgrade has been priced into the market, which means that SA’s dollar-denominated debt still trades relatively well when compared to other emerging countries that have poor investment-grade status.
However, a downgrade to junk status is a serious setback for SA. It may weaken the rand and increase the price of fuel. As we know, when the petrol price increases, so does the cost of living – so you could feel the pinch and see the effects in your own back pocket.
What can you do as a young professional to prepare for the effects of a downgrade?
During this time, it
may be a good idea to have a look at your own outlook for the future – especially in terms of your own finances.
It may be an ideal time to set your savings goals and put some money aside. Debt can be a burden too – if you are currently in debt, you may wish to pay off some of it. In order to live within your means, it’s vital to budget efficiently.
Looking to the future, you may want to diversify your investments – perhaps with a foreign currency or offshore transactional account, exchange-traded funds, or by seeking advice from a reputable financial adviser.