Blog: 5 May 2016 (Impact of Credit Downgrade for SA)

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While a lot has been reported in the news and financial media regarding the possibility of a credit downgrade for South Africa to "junk" status, not a lot is said about how this will impact on South African consumers. Why should they be worried about it? To be honest, they should be worried. Very worried.

So what will happen when South Africa is downgraded to "junk" status?
  1. The cost of borrowing for the South African government will increase sharply: Investors will need to be compensated for the increased "risk" of lending money to "junk" status countries. For example if the South African government wanted to borrow $1billion  over 5 years, before "junk" status they might have paid 5% interest on the loan. When it comes to "junk" status the South African government might have to fork out closer to 8% in interest on the same loan. Silly example but the additional costs of the above example amounts to R1.24billion extra the South African government has to pay off in interest. Money that could have been spent on other things such education, housing, policing etc. is now being spent on interest
  2. The Rand will depreciate: As money flows out of South Africa as investors will be less inclined to invest in South Africa.
  3. Interest Rates will go up: The South African Reserve Bank (whose mandate is inflation targeting), will state they worried that the weakening exchange rate will lead to higher inflation (as imported goods become more expensive). To curb inflation their only tool is to raise interest rates, even though raising rates might have no impact on the inflation rate as its caused by factors outside consumers control. See our Cost Push vs Demand Pull inflation article.
  4. Economic growth will slow: As interest rates go up, consumers will be spending more and more money on 
5. Paying off debt (see our graphics below), and less money will be available for every day goods and services, reducing demand in the economy and leading to an economic slowdown. Currently 78% of consumers disposable income (income after taxes) is spent on paying off debt. And 9.5% of consumers disposable income goes towards servincing the cost off debt (I.e. paying off the interest on debt owed).  This is set to increase substantially in coming months if we are downgraded and the Reserve Bank s increases interest rates. Making already heavily indebtted South African consumers feel the pinch even more.​ The same goes for government as more of their money goes towards paying off debt, instead of suppling services to the economy and stimulating demand.

6. Massive job losses: Due to weaker demand as mentioned above and higher interest rates, companies will struggle as they need to pay more of their money to pay off their debt, while demand in the economy has slowed down. For them to survive tougher times they need to cut costs. And a large chunk of companies costs is employment costs, and to cut back on this they will start retrenching people (see our Financial Well-being of South African Companies article). 
chart created with amCharts | amCharts
chart created with amCharts | amCharts
South Africans should head the calls for tightening their belts. South Africa is in for a very tough time if we get downgraded to "junk"status. Which seems more and more likely, as even the Reserve Bank is preparing for it based on their latest utterings in their financial stability review.  And the Rand's performance over the last two weeks seems to show the markets think its a done deal.

Time for staycations and less wining and dining at coffee shops.

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