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Why Moody's is not being 'horrible' - economist

Mar 10 2016 07:49
Carin Smith

Cape Town - Ratings agencies like Moody's are not putting SA on review just to be "horrible", but because poorer people and poorer countries struggle to pay back debt, emphasised Mike Schüssler of Economists.co.za.

"They will also look at how SA's budget is doing - and our current account did a bit worse in the fourth quarter - so they will be concerned. The combination of these things will be the types of things they will look at, apart from speaking to Sarb and Treasury," Schüssler told Fin24 on Wednesday. They will most likely also talk to overseas analysts.

Moody's has placed SA on review for a possible downgrade, which would place its rating on SA in line with that of Fitch and S&P's BBB- rating on foreign currency debt.

Moody's Investors Service announced that it has placed SA’s Baa2 bond and issuer ratings on review for downgrade. It was prompted by the continuing rise in risks to SA's medium-term economic prospects and to its fiscal strength, notwithstanding the tighter fiscal stance undertaken in the 2016/17 budget, Moody’s said.

"It is not the end of the world being at a non-investment grade. It will make things more expensive, but does have an impact on the way government and business are talking and how the government views it now - to see how important economic growth is first and not redistribution," said Schüssler.

"This is a necessary adjustment we are going through, I think. The ratings agencies are telling us what things are about for our own good as well."

He added that not every ratings agency gets it right all the time. Where it makes a difference, though, is in relation of where overseas pension funds are allowed to invest.

"Ultimately SA could go from a country where they can put 50% of their funds to only being able to put 1% to 5% in SA - and we need their money," said Schüssler.

"Nobody gives you money to throw away. They want a return."

All in the timing

For Schüssler it looks likely that Moody's will downgrade. He sees a 70% chance of such a downgrade to one notch above junk, but emphasised it will not be immediate. It could be in the next six months to a year or even 18 months.

He pointed out that Moody's is different to the other two big ratings agencies - S&P and Fitch - in that they do their ratings at specific times, namely June and December. Moody's, on the other hand, is not tied to any specific period.

Schüssler also pointed out that Moody's was the first to upgrade SA to investment status about 18 years ago and the other agencies only followed about two years later.

"Moody's is still the agency that has rated us the highest and we are still two notches above junk status with them," said Schüssler. He added that Moody's regards the growth rate forecast in Budget 2016 as a bit optimistic and also referred to factors like low commodity prices and the impact of the drought.

"When a ratings agency looks at a country, they will also look at the affordability of our debt and that depends on our GDP per capita. For many years it has been increasing, but the last few years it has been decreasing. That is probably not the only factor for them, but the biggest indicator any ratings agency will look at," explained Schüssler.

With continued downside risks to SA's medium-term economic growth prospects and, therefore, the country's overall fiscal strength, a downgrade by Moody's is probably more likely than not, MMI economist Sanisha Packirisamy told Fin24 on Wednesday.

On the lookout

The ratings downgrade watch will allow Moody's to assess to what extent SA government policies can stabilise the economy and restore fiscal strength in the face of heightened domestic and international market volatility.
"Despite National Treasury tabling a tighter fiscal stance, the subdued growth environment continues to place downward pressure on revenue collection, threatening government's fiscal consolidation timeline," explained Packirisamy.

"All three ratings agencies have expressed concerns over the medium-term trajectory of growth in SA and the lack of progress on planned structural reforms to boost SA's growth prospects against a soft commodity price environment."

She said given that S&P and Fitch currently rank SA's foreign currency debt one notch lower than Moody's, a downgrade by the latter is unlikely to have a significant impact on the currency on a sustainable basis.

However, the key review to pay close attention to, in her view, will be the biannual review of SA's sovereign rating outlook on June 3 by S&P - it is BBB- and currently on negative outlook - and Fitch - which is BBB- and currently on a stable outlook.

"A further deterioration in SA's government debt to gross domestic product (GDP) ratio - on a gross and net basis - has left SA more vulnerable to adverse growth shocks and negative sentiment," said Packirisamy.

"Should S&P move SA's sovereign debt rating to sub-investment grade as early as June or December this year, the impact of junk status would likely be felt immediately in the currency channel."

She explained that rand weakness leads to higher expected inflation, which would trigger an interest rate response from the SA Reserve Bank (Sarb). Three to four quarters later the impact of higher rates would start to negatively impact domestic demand growth.

Fiscal policy

In addition, fiscal policy then also has to be tightened in an effort to prevent further ratings downgrades by trying to improve debt metrics, with spending cuts and tax increases putting additional pressure on economic growth.

"As there is significant pressure on the fiscus due to higher interest costs and lower (economic and revenue) growth, higher taxes (personal taxes, fuel levies and as a last resort VAT) will be forthcoming, while cutbacks on government expenditure - hopefully on current/goods and services expenditure and not capex - is inevitable," said Packirisamy.

"Consumer spending will, therefore, come under pressure due to the negative fiscal impact of higher taxes and lower government expenditure on spending power, with real discretionary incomes also eroded by higher inflation and rising interest rates."

Furthermore, consumption spending also gets hurt by a cutback on employment by the public and private sectors in response to budget constraints, as well as by the negative wealth effect from falling financial market assets, she explained.

"Both the middle-to-higher-end consumer (through higher personal taxes and interest rates and a negative wealth effect) and the middle-to-lower-end consumer (through higher inflation and VAT and lower employment) are adversely impacted by this," she said.



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