Johannesburg - Another rating downgrade “could have far-reaching implications” for South Africa, the Reserve Bank warned yesterday. Among the dangers identified in the bank’s financial stability review is that the country might fall out of Citi’s world global bond index, which provides a benchmark for institutional investors.
The bank estimates South Africa’s inclusion in the index a year ago has attracted R60 billion in capital flows.
The country’s rating has already been cut one notch by three agencies over the past 13 months. And the agencies have expressed concern recently at the size of the budget deficit – the gap between government spending and revenue – and confusion over policy. Rating agencies’ reaction to last week’s medium-term budget policy statement has been mixed.
Currently Standard & Poor’s (S&P) has South Africa at BBB, one notch above the speculative grade threshold, and Moody’s Investors Service has it at Baa1, two notches above. As the rating falls down the scale, passive investors may maintain their exposure but “more active investors may reconsider their portfolio exposures”, according to the bank.
When a country’s rating fell below BBB- (from S&P) and Baa3 (from Moody’s), it “could be removed from the next month’s profile and moved to additional market indices”. This demotion would reduce funding from institutional investors, which have to follow strict guidelines on the quality of their investments.
Kevin Lings, the chief economist at Stanlib, explained: “Many investors would get nervous after a downgrade of S&P, because one notch above speculative grade does not provide much of a safety net, especially if we are kept on a negative watch.” But he noted: “A downgrade by Moody’s would bring its rating of South Africa in line with S&P and Fitch, so I don’t think this would have much impact on the world global bond index debate.”
Below the investment threshold, bonds are described as speculative grade or simply junk. Countries classified as junk find it costly and difficult to obtain credit.
The lower the sovereign’s rating, the higher the interest bill – and the government already spends about 8.7 percent of its budget on servicing debt. It is not only the government that will pay more: state-owned enterprises and private business will be downgraded along with the sovereign.
The series of downgrades will lead to higher interest rates all round which, in turn, will work their way through to South Africa’s heavily indebted households.
Nicky Weimar, the senior economist at Nedbank, suggested the Reserve Bank, which is responsible for banking supervison, had raised the issue because inclusion in the index had been a source of steady funding in South Africa. She said that a rating downgrade would indirectly affect the banking industry, “through the risk of bad debts and defaults”.
Because South Africa runs a wide current account deficit – the gap between revenue from exports of goods and services and the import bill – the country depends heavily on inflows on the financial account to keep the economy ticking over. If these flows dried up, the economy’s ability to grow would be reduced further.
On a different tack, the bank highlighted the “resurgence” of shadow banks, both globally and domestically. These are non-banks performing “bank-like activities”.
The review said non-bank lending “has a legitimate role in increasing access to finance of borrowers experiencing funding shortages”. But it warned these institutions were not strictly regulated and could pose a “systemic risk” – in other words they can trigger a domino effect in the economy. - Business Report