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We’re junk. What now?

Apr 13 2017 10:44
Simon Brown

So, we’re junk. Standard & Poor’s downgraded our foreign debt to junk (that’s about 10% of our borrowing) leaving our local debt a notch above junk. Technically we needed two junk ratings to be considered junk as a country; and then Fitch downgraded both local and foreign debt, so junk status is official. 

This leaves the country in a very tough space with new government debt going to cost more and a weaker rand threatening inflation. This, coupled with a GDP that is likely to decrease, and potentially higher interest rates, means it’s going to get very ugly for the economy. 

The local banks were also downgraded as they cannot hold a higher rating than their sovereign and as I write on 7 April the Fini15 Index is off some 10% since former finance minister Pravin Gordhan was recalled from London on 27 March. 

The real pain for the economy will only start in 2018. We’ll certainly see more tax increases next year as the cost of new debt increases and government revenue continues to be under pressure. 

Personally, I have been positioned for this since December 2015 when then finance minister Nhlanhla Nene was fired, and I wrote about exiting banks (except Capitec*, which I reduced but continue to hold), being very careful of local stocks closely related to the state of the economy, and focusing on offshore earnings and very solid local earnings. 

The next few years are important. Following the downgrade to junk, we can expect the economy to take at least seven years to get back to investment grade. 

The flip side is the stock market and the Top40 is about 3% higher since the Gordhan recall, largely on the back of the rand hedge stocks moving higher. Back in November I wrote how the Brazilian stock market rallied after its downgrade to junk. That trend has continued with the Brazilian index, the IBOV, just off the all-time highs from 2008. That country has even seen its currency strengthen during that period, all while its economy has been struggling in a recession.

Will we follow Brazil with a move higher after the dust has settled? I have no idea, but for now my strategy is to be cautious. Our Treasury has seemingly been captured and our state-owned enterprises (SOEs) are a mess, but my prediction is that after the ANC elective conference in December, President Jacob Zuma will be much weaker and will likely be recalled (or resign) in early 2018. Then we can start rebuilding our SOEs and the economy. This is a slow process, but one we went through before, after the apartheid state was overthrown. The economy is nowhere near as bad as it was back in 1994. 

I have been buying some Tongaat* in the mid-R120s to below R120, otherwise I am adopting a wait-and-see approach. If our market does start to rally higher, we’ll have lots of time to enter positions, we don’t need to take on the risk just yet. 

If you have any debt, pay it off as rising rates will hurt. If you’re considering buying a house or a car, downscale your plans and go for a cheaper option to reduce future debt. We need to protect our personal balance sheets and debt will add risk, especially if interest rates start moving higher. 

A last important point is that this is not the end of the world. We’ve been junk before, as have many other countries, and we’ll survive, but this is going to be a long and painful journey. 

*The writer owns shares in Capitec and Tongaat Hulett. 

This article originally appeared in the 20 April edition of finweek. Buy and download the magazine here.

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