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Now the media has covered rather extensively the cabinet reshuffle insituted by President Jacob Zuma, and the concerns is raises regarding whether the "Zupta" crony machine has finally found a way to get rid of Pravin Gordhan so they they can raid and plunder the National Treasury. One suspects that this is the case when looking at the cabinet reshuffle.
Performing ministers such as Pravin Gordhan and his deputy Mcebisi Jonas (who spoke out about state capture and reported Zuma's Gupta buddies offered him R600million if he took up the job as finance minister and did certain favours for them). This happened before Jacob Zuma fired Minister Nene in which is now known as Nenegate. So the Guptas have been trying for a while to get one of their cronies or a corrupt official as the head of Treasury so that they can ensure government spending is aimed at enriching them and their companies. Warnings of SA being downgraded has been making the rounds for months as Gordhan and Jonas tried to assure foreign investors and ratings agencies that government will stick to their fiscal discipline plans outlined in the Medium Term Budget Framework. With Pravin and Jonas removed and Gupta crony now at the head of Treasury, ratings agency S&P decided that this is the final straw for SA. And they held a emergency meeting and decided to downgrade SA's sovereign debt as "Junk". So now the question is. What does it really mean for South Africa? |
SA's junk status history
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Impact of "Junk Status"?
The impact of "Junk status" cannot be defined by one single event. It does however set of a chain reaction which cumulative effect on South Africa is going to be devastating and it will take South Africa a long time to recover from properly. And due to SA's fragile economy such recovery will take even longer. To be honest South Africa's economy has still not fully recovered after the sub prime mortage crises in the US (which lead to the financial crises sent economies all over the world into recession). Largely due to its significant dependence on commodities, the depressed commodity prices following the financial crises has not helped SA's economy recover.
So now we know our recovery will be slow and painful, but what do we need to recover from?
So now we know our recovery will be slow and painful, but what do we need to recover from?
Firstly. "Junk status" from ratings agencies is a way of telling investors that the quality of the bonds of this government is not the best. And that there is risk here of investors not receiving all the interest or the value of the bonds back when it matures. Simple economics 101, increased risk implies investors require increased rewards. Thus the yield (interest rate) that South Africa's government has to offer on money it is looking to borrow by issuing government bonds has to be higher to compensate investors for taking the increased risk of buying South Africa's government bonds.
So South Africas government cost of borrowing goes up. More money has to be spent on repaying interest. Money that could be used for social upliftment projects, improved infrastructure, fighting crime, social grants etc. More money spent on interest is more money not being spent in SA on South Africans. Overall impact of this is a poorer quality of life and slower economic growth. And this is something South Africans have been getting used to in recent years and will probably have to get used to for the forseeable future. Below a graphic showing South Africa's GDP per capita (per president). GDP per capita essentially shows the value of a economy divided into the number of citizens in a country. I.e the value of a country's economy per person living in it. And is used across the world to measure a country's welfare and economic standing. And as readers can see the story in SA's recent past has not been a very good one.
So South Africas government cost of borrowing goes up. More money has to be spent on repaying interest. Money that could be used for social upliftment projects, improved infrastructure, fighting crime, social grants etc. More money spent on interest is more money not being spent in SA on South Africans. Overall impact of this is a poorer quality of life and slower economic growth. And this is something South Africans have been getting used to in recent years and will probably have to get used to for the forseeable future. Below a graphic showing South Africa's GDP per capita (per president). GDP per capita essentially shows the value of a economy divided into the number of citizens in a country. I.e the value of a country's economy per person living in it. And is used across the world to measure a country's welfare and economic standing. And as readers can see the story in SA's recent past has not been a very good one.
So higher borrowing costs, slower economic growth and lower standard of living is the first in our chain reaction. So what's next? Since investors know that a downgrade to junk will set of the chain of events we mentioned above, they start looking elsewhere around the world for economic growth and higher returns on their investments. This leads to a depreciation of the exchange rate as the demand for Rands fall as investors are less keen on investing in SA and would rather go elsewhere.
A weaker exchange rate means SA's imports are more expensive. And since we import a lot of essential items with very little price elasticity we have to import it regardless of the price. Think of crude oil for example. South Africa will import it regardless of the Rand price of it as it is needed to make petrol and diesel and without it all cars in SA will grind to a halt. Imported essentials become more expensive and this feeds through into higher prices as wholesalers and retailers pass the price increases on to consumers, leading to higher inflation. Higher inflation leads to higher interest rates as the Reserve Bank will raise interest rates to try and curb spending which in turn they hope will lower levels of inflation. As consumers spend less retailers and wholesalers will lower prices to move their goods faster, but this eats into their margings, which if sustained, will lead to job losses as wholesalers and retailers try and cut costs.
On the flip side a weaker exchange rate is supposed to make South Africa's exports more competitive, but unfortunately South Africa does not export a lot of essential goods such as crude oil. Countries can go without importing gold or platinum or coal from SA for a while.
A weaker exchange rate means SA's imports are more expensive. And since we import a lot of essential items with very little price elasticity we have to import it regardless of the price. Think of crude oil for example. South Africa will import it regardless of the Rand price of it as it is needed to make petrol and diesel and without it all cars in SA will grind to a halt. Imported essentials become more expensive and this feeds through into higher prices as wholesalers and retailers pass the price increases on to consumers, leading to higher inflation. Higher inflation leads to higher interest rates as the Reserve Bank will raise interest rates to try and curb spending which in turn they hope will lower levels of inflation. As consumers spend less retailers and wholesalers will lower prices to move their goods faster, but this eats into their margings, which if sustained, will lead to job losses as wholesalers and retailers try and cut costs.
On the flip side a weaker exchange rate is supposed to make South Africa's exports more competitive, but unfortunately South Africa does not export a lot of essential goods such as crude oil. Countries can go without importing gold or platinum or coal from SA for a while.
So we do not really benefit as much in terms of export trade when the exchange rate is weak compared to the increased costs we incur by importing essential items. Net effect is a greater trade deficit (I.e SA pays more to the world for its imports than what the world is paying it for its exports). Thus just pushes the exchange rate down even further as the Rand will continue to weaken till the point were SA starts importing less essential items as it is to expensive and our exports become so cheap that foreign countries import from us even if the good or service is not essential. But reaching that point could take a very long time. Below a graphic showing th exchange rate each year (per president) and again the story it tells is not pretty.
While the government will claim the exchange rate's performance is due to a strong dollar, emerging market risk aversion, commodity price slump lowering demand for the South African currency, they cannot dispute the fact that since Jacob Zuma took over as president of South Africa, the currency has been slaughtered. And with political infighting, "invisible hands" and state capture, crony capitalism and general lack of good governance withing government, the world is sending the ruling party in South Africa a very clear message with the current level the exchange rate is sitting at. Pull your socks up or you in for a whole world of pain.
We wrote this on 1 September 2016 and we suspect a lot of this will now materialise after Zuma got rid of Praving Gordhan.
"A ratings downgrade seems all the more imminent due to the "Zuma camp" continued efforts to target finance minister Pravin Gordhan. And this all so that racketeering and further looting of state coffers can take place to the benefit of a select few, while the country as a whole will suffer for years if our ratings are downgraded. A few things the factions within the ANC needs to consider before continuing down this path. If South Africa is downgraded to "junk" status the following will likely happen:
We wrote this on 1 September 2016 and we suspect a lot of this will now materialise after Zuma got rid of Praving Gordhan.
"A ratings downgrade seems all the more imminent due to the "Zuma camp" continued efforts to target finance minister Pravin Gordhan. And this all so that racketeering and further looting of state coffers can take place to the benefit of a select few, while the country as a whole will suffer for years if our ratings are downgraded. A few things the factions within the ANC needs to consider before continuing down this path. If South Africa is downgraded to "junk" status the following will likely happen:
- Exchange rate will hit levels never seen before. It will make "Nenegate" look like a picnic.
- Inflation will skyrocket. As all imports will become way more expensive. Including crude oil which is the life blood of any economy as it powers most vehicles and machines.
- Interest rates will see massive hikes. The Reserve Bank will try and curb inflation by raising interest rates. Indirectly trying to protect the Rand so we import less inflation
- Government debt will become way more expensive to pay off overnight. Taking on new debt will be harder and cost a lot more. How will government finance that? Raise taxes? South Africa is already seeing a tax revolt. Think E-tolls. Cant keep milking a cow if there is no milk left. South Africa has been milking a small part of the population with taxes for far to long. Our tax net is not wide enough and is already unsustainable.
- Since government has to pay more money to service debt, there will be less money to provide services to it's citizens. And this will lead to more protest actions and riots. And eventually voters will finally be fed up with the government of the day, and they might finally decide that a new ruling party is needed to run this country.
So be careful those who are playing the factions game within the ANC. Because you might be cutting your nose to spite your face. The gain of a few citizens in a country will never outweigh the greater good for all the citizens in a country."
Sadly we have now reached that point where SA has been downgraded by one of the major ratings agencies and others are sure to follow. And to those think it is not that bad and paying a little more for debt is not the end of the world. Just remember South Africa is sitting with outstanding debt owed to the world of R2trillion. That is almost 51% of the value of SA's economy. We have a mountain of debt to pay, and adding more interest to it is not making the government's job of repaying it any easier. In January 2017 alone South Africa issued fixed rate bonds of R9.4billion.
Now the yield on the R9.4billion borrowed in January was around 9.37%. Now that we are junk lets assume investors demand an additional 0.5% to compensate for increased risk. Interest to be repaid on R9.4billion borrowed now compared to January would be R40million more than what it was in January 2017. Imagine what SA's government could have done with that R40million. And this is just one month's government fixed rate bond issue. Imagine the overall impact over a year, or two years. It is costing our country millions and millions more in interest and the net effect will be billions and billions. And this all so that a few corrupt businessmen and their politcal pawns can plunder.
Now the yield on the R9.4billion borrowed in January was around 9.37%. Now that we are junk lets assume investors demand an additional 0.5% to compensate for increased risk. Interest to be repaid on R9.4billion borrowed now compared to January would be R40million more than what it was in January 2017. Imagine what SA's government could have done with that R40million. And this is just one month's government fixed rate bond issue. Imagine the overall impact over a year, or two years. It is costing our country millions and millions more in interest and the net effect will be billions and billions. And this all so that a few corrupt businessmen and their politcal pawns can plunder.
SA's junk status history?
While we discussed the impact of "junk status" on South Africa at length above, the graphic below shows the credit ratings history of South Africa since 1994 for Moody's, Fitch and S&P. And as can be seen from the graphic above, South Africa has been graded as "junk status" before. And we got out of it. But it took a lot of hard work from a very competent team at National Treasury under the guidance of Minister Trevor Manual.
Interesting observation of the credit ratings graphic is the fact that Moody's has historically seen South Africa in a better light than S&P and Fitch. As their credit ratings of South Africas sovereign debt has always been higher or on par with that of S&P and Fitch, but never lower. And Moody's have not ranked South Africa as junk status yet. And lets hop this remains the case for South Africa, as a "junk status" from all three the big ratings agencies will not bode well for South Africa.