Junk status for dummies: Why the real junk is yet to come

Cape Town – There are two crucial credit ratings that have yet to be downgraded to junk status. If and when they are cut, South Africans will truly be a country in junk status.

Before we understand more about these specific ratings, let's recap.

There are three important rating agencies that determine South Africa’s credit ratings:

• Moody’s
• Standard & Poor’s (S&P) Global
• Fitch Ratings

There are two types of ratings that economists focus on:

• The long-term foreign currency debt ratings
• The long-term local currency debt ratings

National Treasury issues bonds to fund South Africa’s growing debt. In 2017, it will fund a portion of its R1.54trn budget by borrowing R149bn or 3.1% of the country’s gross domestic product. About 90% of these bonds are issued is local currency, while about 10% is issued in foreign currencies.

Banks, big businesses, state-owned entities and local governments have their own ratings, which differ from the above, but which are often impacted by the sovereign rating.

You would have seen this after Moody's downgraded South Africa recently: a domino effect occurred, where the top banks and Eskom, among others, were downgraded.

Following President Jacob Zuma’s controversial Cabinet reshuffle on 31 March that saw the removal of Pravin Gordhan as finance minister, the rating agencies have wielded their axe on South Africa’s credit ratings.

The below table reveals where South Africa now stands:

• Moody’s has South Africa’s long-term foreign and local currency debt ratings one notch above junk status. Its outlook is negative.
• S&P has South Africa’s long-term foreign ratings at junk status and local currency debt ratings one notch above junk status. Its outlook is negative.
• Fitch has South Africa’s long-term foreign and local currency debt ratings at junk status. Its outlook is stable.

What it means

As can be seen above, there are three ratings that are in junk status and three ratings that are one notch above junk.

The two important ratings that have yet to be downgraded to junk status are S&P and Moody’s local currency debt ratings.

The importance of these potential downgrades is that 90% of Treasury’s bonds are issued in the local currency.

It is also important because it will force South Africa off the Citi World Government Bond Index (WGBI), which will make it compulsory for many firms to sell this bond.

“The potential foreign capital outflow associated with SA bonds dropping out of the WGBI has been estimated between R80bn and R130bn,” explained Momentum economist Sanisha Packirisamy and head of asset allocation Herman van Papendorp.

“Following the recent ratings moves, Momentum Investments acknowledges the increasing risk of SA bonds dropping out of the WGBI over the next 12 months,” they said in a statement on Monday.

“Exclusion from the WGBI could have a longer-lasting impact on foreign flows into SA,” they said. “Citi has warned should the exclusion be triggered, the criteria to be re-included are reasonably onerous, including a four notch ratings upgrade which could take several years to achieve.”

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