Emotion must be kept in check as South Africa searches for real solutions, writes Neva Makgetla.
It's hard to stay level-headed about the ratings agencies’ downgrade of South Africa.
There are so many things in the mix: the emotive word “junk” – are we now worthless as a country?
The ill-disguised glee of the political opposition, expecting the economy to crater and bring them into power; the proudly know-nothing pushback from some Zuma supporters, who act as if an economic downturn would somehow be good for transformation.
And the panic-stricken tone of much of the press and financiers, who seem to think that hyperinflation is around the corner.
To go beyond the downgrade hysteria requires a systematic unpacking of how the ratings agencies affect investment.
Two issues arise: first, will it really cause an economic Armageddon? And second, should we take the ratings agencies’ dismissive evaluation of South Africa seriously?
In terms of the impact, experience in other economies suggests the downgrade will ultimately have only a fairly modest impact.
The role of ratings agencies is to help investors evaluate the risks of specific investments – in this case, the likelihood that South Africa will default on its debts.
By extension, the downgrade will accelerate the outflow of capital from the stock and bond markets. This is particularly true for American pension funds, which are required by law to avoid holdings that the ratings agencies consider speculative.
The loss of foreign funds means, first, that government and private companies will effectively have to pay more to borrow. That in turn will tend to squeeze state services, as government pays more on its debt. It could also affect investment by both state-owned enterprises like Transnet and Eskom and by private companies. Both of those effects will act as a drag on the already slow economy.
Second, the outflow may push down the value of the rand, which is both good and bad for growth. On the upside, it makes export industries and tourism more competitive. In the past few years, depreciation has been critical for the survival of the mines as well as the upsurge in auto and some other manufactured exports.
But there is a price to pay: it also makes imports more expensive, which can add to inflation.
It’s not clear, however, if the downgrade will decisively affect capital flows. In the past few years, investment has already been flooding out of South Africa. From 2014 to 2016, foreigners sold R200 billion in South African stocks and bonds.
That’s a core factor behind the depreciation of the rand.
That outflow results, not from the ratings agencies, but from the end of the commodity boom. South Africa still depends on mining exports. The prices of metals and coal soared from about 2002 to 2011, but then fell sharply. In constant dollars, metals prices in 2011 were far higher than at any time since 1980, but then they collapsed by well over half. Since then, growth has been much slower and harder to forecast.
The commodity boom turned South Africa into an attractive destination for international capital, especially because our sophisticated financial markets make it easy to invest.
From 2001 to 2013, the share of foreign holdings in the Johannesburg Stock Exchange climbed from 4% to 33%. With the end of the commodity boom, the figure dropped to 27% last year.
Foreign lenders were also increasingly important for government. Only a tenth of South African debt is issued abroad. But the share of domestic bonds held by foreigners climbed from 13% in 2008 to 36% in 2016.
In short, capital flows into and out of South Africa essentially followed metals prices over the past 15 years. From this standpoint, the ratings agencies trail the market, rather than leading it. More precisely, investors all follow the same signals – and the ratings agencies both reflect those indicators and communicate them.
A second issue is whether the ratings agencies are infallible policy pundits.
Essentially they are dominated by three private companies – Standard and Poor’s, Fitch and Moody’s – that earn fees by helping investors estimate risks. They aren’t endowed with godly wisdom or insight, although they have a lot of expertise and technical capacity.
In the event, the ratings agencies have gotten it spectacularly wrong on occasion. In the run-up to 2008, at the height of an asset bubble, they rated a lot of truly toxic housing bonds as top-flight risks. As a result, a lot of institutions bought them – and ended up losing billions.
This doesn’t mean the ratings agencies always get it wrong. But their perspectives should be considered like those of any other experts: tested against the evidence as well as other views.
Research shows that ratings are mostly determined by economic growth. In other words, when the GDP is flying high, sovereign risk ratings improve; when growth slows, they drop.
This certainly fits the South African case. Growth began to improve from the early “noughts”, as metals prices climbed internationally – and we emerged from “junk” status around the same time. Growth slowed dramatically as metals prices crashed in 2011, and our sovereign risk ratings declined in step with it.
If it’s any comfort, we are not alone in this process. Brazil and Russia have both been downgraded to junk since the commodity boom ended. In fact, half of all countries with risk ratings are below investment grade.
In the uproar about the downgrade, the real questions often get overlooked. Most urgently, the question is how civil society and citizens can protect our democratic institutions from the kleptocratic onslaught. And in the longer run, we need to do more to ensure that growth is more equally shared. Because in the end, only a more equitable economy can secure stable economic growth. The ratings agencies won’t guide us in meeting either of these core challenges.
* Makgetla is senior economist at Trade and Industrial Policy Strategies in Pretoria.
** The views expressed here are not necessarily those of Independent Media.