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Moody’s decision to leave SA’s credit rating unchanged gave the country a welcome reprieve. However, downgrade risks still remain and next Friday, 3rd June, will be the day we know our reckoning when S&P (Standard & Poor’s) give their verdict on the creditworthiness of our nation.
Wikus Furstenberg, portfolio manager at Futuregrowth Asset Management, is of the view that the downgrade is inevitable. Our stunted growth, high unemployment, poor growth of human capital and the politics du jour all point to the S&P decision next week being firmly negative. He does however have some interesting views on what happens next. – Candice Paine
This podcast is brought to you by Futuregrowth Asset Management and Candice Paine is with Wikus Furstenberg , Portfolio Manager at the group. We’re going to talk a lot about the imminent credit rating decision next week (Friday, on the 3rd of June) from S&P. We’ve already seen Moody’s come out and we had a slight reprieve there. Wikus what do think is going to happen on Friday, and the possible effects this decision will have on SA’s economy.
Hi, Candice. Thank you very much. I think a lot has been said about rating agencies, especially the next two weeks or so, and so it’s really difficult to add anything new to that. For what it’s worth, on our side we have been assuming a downgrade by S&P over the last eight months or so in our valuation models.
It’s not really helping because the market’s already priced the possibility of the downgrade to sub-investment by S&P, in particular. Obviously, there we take our cue from what’s been happening in the credit default stock market as well as local currency bond yields. They’re back to levels where we last had a sub-investment grade rating in early 2000.
For now, I don’t think that the market is going to move much if we see the downgrade from S&P by next week or so. In my mind, the surprise is going to be if they don’t downgrade us in the next week so even if that means they’re going to do it in December.
There will probably be some sort of positive impact on the market – both the currency market and the demand market. As I said, the market is priced for a downgrade. The third scenario is where we actually see S&P downgrade South African either now (in June) or in December and at the same time, keep up the outlook negative. I.e. implying that your next downgrade is around the corner.
The market is not priced for that. That’s a distant scenario so we attach a low probability to that at the moment. As I mentioned, our base case is for a downgrade (either now in June or in December) and obviously, the impact on the markets is going to be different.
Why? It’s mostly because of our inability to generate sustainable economic growth at high levels, the inability to generate employment, and the inability to develop human capital in South Africa.
These are structural issues, which Government failed to address over a number of years. It’s less about what’s been happening now in terms of the fiscal side and even less so about what’s been happening in terms of the uncertain political backdrop and the event that we all know about, in December of last year.
Wikus, you say that this has been coming for many years – this slowing economic growth, the lack of growth of human capital, and the lack of growth of jobs, which is completely spot on. How long would it take us to get out of this scenario if it happens (now that your base case is that it is happening)?
It’s really a function of how we recover. We need to go back to a higher growth path for the right reasons preferably locally generated, and better macro policies as a function of that. That’s why I really can’t give you an answer. I don’t know how long that’s going to take. Simplistically speaking, it tends to take a while.
It tends to take a few years for that to happen. I think that in this case, we need to deliver and we need to convince rating agencies that if there’s an improvement in terms of economic growth, the ability to generate employment (not only by Government but by the private sector too) with the Government allowing the private sector to generate more employment, you need time to convince them.
It’s not going to happen in a matter of six months so it’s going to be a while for that to materialise.
Read also: Andrew Canter: $1.25bn Eurobond shows SA is already being treated like a “junk” borrower
In the interim, you say that the effects of this downgrade are already priced into the market. What have you seen?
The first important thing is what happens to Government’s funding cost and that’s already gone up. Recently, they issued the Dollar-denominated bond and it was issued at a spread well over 300 basis points over the US.
Treasury curve, which reflects sub-investment grade. It is already more expensive to borrow offshore and locally… Obviously, local deals where they do most of their funding, (which is a benefit in a way because you have some sort of protection against currency weakness when you service your debt) has gone up as well.
Now, in the short-term, it’s not going to have a huge impact but over time if it stays at these levels compared to a few years ago, it most certainly will have a negative impact in terms of funding costs and what is left in terms of the Budget, to spend on more important things.
What does that mean for the man in the street and particularly, the poor?
Indirectly, we could link that to two things. One is the currency weakness. The impact currency weakness has on inflation. We all know that the poor’s biggest enemy is inflation. That’s why the central bank is so sensitive to inflation expectations. The second thing is what happens to the Budget over time.
If we don’t see a recovery, obviously it implies that Government needs to set aside more money to service its debt. It implies that there’s less on the table with which to divide and support the poor.
So all around Wikus, you’re seeing a downgrade next week Friday and the implications are not good for South Africa. Thank you very much for your time. That was Wikus Furstenberg, Portfolio Manager at Futuregrowth Asset Management.
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