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Downgrade: The immediate consequences for South Africans

Apr 18 2017 19:10

Cape Town – It’s crucial that investors and South African citizens remain calm and make informed choices, following the recent downgrade of South Africa’s sovereign credit ratings downgrade, said Kirk Swart and Brett Birkenstock of Overberg Asset Management. 

In the first week of April, Standard & Poor (S&P) Global Ratings and Fitch Ratings both downgraded South Africa to sub-investment grade, also known as junk status. 

The two ratings agencies both cited President Jacob Zuma’s decision to reshuffle his Cabinet as the main reason for their decisions, fearing that the move could signal a change in policy direction. 

READ: INFOGRAPHIC: How junk status will affect you

Swart and Birkenstock agree that the full impact of junk status will be fully realised over time, but highlighted some of the immediate implications for the country. 

Higher inflation 

The downgrade is forcing big international bond funds to sell out of South African bonds. “When bonds reach sub-investment grade, many bond funds are forced to sell the bonds. As we all know, South Africa is a net importer. This means we are importing more than we are exporting. 

READ: Petrol price hike will bite consumers - economist 

“With the foreign bond funds selling South African bonds, the rand is more than likely to weaken. This will make imports more expensive. Items like fuel and food will increase in price and hurt the already fragile economy,” said Swart and Birkenstock. 

Interest rates – higher for longer 

Before the downgrade the South African Reserve Bank (SARB) indicated that inflation might be heading lower, moving back into the 3% to 6% target range.

“Normally this situation will lead to the SARB decreasing interest rates. However, since the downgrade, bond yields have increased and with inflation more than likely to increase, the SARB will place a hold on decreasing interest rates,” according to Swart and Birkenstock. 

“This comes at a very unfortunate time as it seemed as if the South African economy is finally picking up. PMI data has shown a slow recovery on the back on increasing commodity prices and rain in the northern part of the country.”

Reserve Bank independence potentially under threat

Swart and Birkenstock argued that the independence of the SARB at this juncture is critical. 

“An independent SARB ensures that monetary and exchange decisions are made independently from any political interference. The SARB is entrusted with stabilising the currency and keeping inflation in check. It is very important for the SARB to keep exchange controls as is, allowing South Africans to take money in and out of the country.”

READ: Why the SARB should be nationalised - analyst

Currently, South Africans are allowed to take R1m offshore through a foreign allowance and up to R10m with a Reserve Bank clearance. 

“When losing independence, the SARB might make it very hard for South Africans to take money abroad in order to shield them against the declining currency." 

Potential job losses and salary freezes

Local companies may struggle to grow profits and revenue in the recessionary environment that the downgrade could place South Africa, said Swart and Birkenstock. 

“This may result in job losses as well as a lack of salary increases or bonuses, which will further affect consumer spending.”

Tax increases could be on the cards

As the government struggles to balance expenditure with revenue at the now higher-cost-of-lending, it is very possible that the government will raise taxes across the board, Swart and Birkenstock said. 

READ: Taxes: feeding an incompetent state? 

“These increases could be in the form of personal income tax, capital gains tax, dividends tax, an increase in VAT (although probably unlikely), an increase in tax on fuel and various other taxes.” 

Skilled people could leave SA 

As taxes increase, the cost of living rises and corporate profitability falls, many young professionals may look to further their careers and start afresh abroad. 

“This can have dramatic consequences for service delivery, corporate competitiveness and even affect basic living in South Africa – think of doctors, nurses, plumbers and electricians.” 

Potential poor returns on local assets

Coupled with the general negative economic outlook, the downgrade could affect South African assets including shares, property, cash (in real terms) and many other asset classes, Swart and Birkenstock said. 

“The demand (from abroad) on South African property could drop as well as the earnings from corporates, which in turn will affect share prices.”

ALSO READ: A millennial’s take on the downgrade: Let the Hunger Games begin

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