There has been recent criticism regarding the relevance of rating agencies for South Africa. It is important to note that these agencies continue to provide useful information for investors and sovereigns and therefore remain critical for the country. Furthermore, they continue to hold governments accountable for their policy proposals.
Credit rating agencies aim at providing an independent assessment about a country’s credit profile in terms of the ability and willingness to repay the debt, the development of the financial system, economic openness, institutional strength and integrity, as well as policy predictability and political stability. These agencies have, however, come under scrutiny in recent years. The role these agencies play and the accuracy of their credit risk assessment has been questioned following the 2008 financial crisis. The difficulty in assessing sovereign risk has led to different assessments by the rating agencies.
Sovereign ratings, however, remain important as more governments with greater default risk borrow in international bond markets.
Ratings agencies serve a number of useful purposes: firstly they aggregate information about the credit quality of a sovereign and its related debt offering. Such information allows investors and sovereigns to access global and domestic markets and attract investment funds, thereby adding liquidity to markets that would otherwise be illiquid.
Secondly, most investors in fixed-income instruments require that their fixed-income holdings have a credit rating. Investors (especially foreign investors) do not have sufficient information about the factors that determine a sovereign credit quality, ratings agencies therefore bridge the information gap between debt issuers and investors. Such an information service by these agencies reduces information costs, increases the pool of potential borrowers and promotes liquid markets. This implies that market prices tend to be influenced by rating announcements.
Thirdly, fixed-income portfolio manager performance is often benchmarked against standard indices that are usually constructed on the basis of credit ratings.
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Fourthly, central banks around the world depend on ratings to determine which securities can serve as collateral for their money-market operations.
Lastly and most importantly, rating agencies hold government accountable for their policy proposals and implementation thereof.
In South Africa specifically, credit rating agencies have played a crucial role in the country’s ability to gain easy access to international capital markets at reasonable costs.
During times of high ratings, South Africa enjoyed lower borrowing costs while, with recent downgrades by these agencies, borrowing costs are starting to rise. However, South Africa still borrows money at a reasonable interest rate. The recent maintenance of an investment grade rating for South Africa has a number of benefits:
* The government has accumulated a lot of debt in the past several years in an attempt to sustain the country through hard times created by the collapse in the US banks in 2008. Currently the government spends close to R150 billion in interest costs on its debt of more than R2.1 trillion (a budget that is almost the same as for social grants and for health). If the cost of borrowing money for government increases (triggered by, among other things, a sub-investment grade rating), it means that the government will have either to cut spending (social and economic) or increases taxes. A further fiscal consolidation will have dampening effects on economic growth, employment and living standards of the poor.
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* For the poor, an investment grade rating may mean that low-skilled work would be preserved or even increased as investors remain confident about the sovereign’s prospects. The government will continue to provide much-needed social services.
* For the middle-class and wealthy households, positive sentiments (due to maintaining an investment grade rating) may translate into manageable debt costs, preserved value of their assets (such as retirement contributions) and no loss of disposable income.
* For business and investors, rising confidence (partly as a result of positive ratings announcements) is likely to fast-track investment and sustain the current employment levels.
Rating agencies have also held the government accountable for its policy proposals and implementation. They have been monitoring the speed in which government policy proposals have been implemented and the urgency at with government takes crucial decisions to unlock potential economic growth.
The concerns raised by rating agencies are known to all South Africans, and the government does not shape policy for rating agencies but for the good of the country.
Some of the concerns raised by these agencies and investors in general are a weakening economic growth, state-owned companies with weak balance sheets, rising government debt and other contingent liabilities, policy and political uncertainty, and a wide current account deficit.
Dr Mampho Modise is the chief director for Strategy and Risk Management at the National Treasury.