Written by Kavisha Pillay Edited by Janina Hundenborn
Junk status… Something all South Africans have been dreading. And on Monday, 3 April 2017, S&P made it a reality. Since then various articles have been written explaining the term and its impact on the South African economy. So much so, that many who had no idea no interest in the economy became experts overnight. Moreover, the immediate reaction was a call for President Zuma to step down. A call that was met with nationwide strikes on Friday, 7 April 2017.
A country downgraded to junk status (or sub-investment grade) is indeed a problem. In our case, our sovereign credit and banks were downgraded. If you don’t know by now, this means that South Africa’s foreign debt was downgraded to junk by S&P and both foreign and local debt was downgrade to junk by Fitch. Essentially, these rating agencies say that the likelihood of this debt being repaid by the South African government is low. But what does this mean for the average person? The decision by S&P and Fitch to downgrade us means that investment funds will sell their debt and invest in investment-grade areas. These investment funds are mandated to only invest in investment grade jurisdictions. While Reuters has said that $10 billion will leave the country, the market has already factored the downgrade in (remember, we’ve been on the edge of junk status since the end of 2015).
As many of you have become economists overnight, I’m sure you’re well aware of the impact of junk status. If not here’s a quick summary: government needs money to run the country. However, as we are a risky investment, the South African government will have to borrow from people who are willing to invest in higher risk debt, which makes borrowing more expensive. South Africa already has a high debt-to-GDP ratio (the ability of a government to repay its debt) of 48%, which has been growing since the financial crisis. A low debt-to-GDP ratio indicates that a country is able to repay its debt. Already from this ratio, government has a lot of debt to repay and interest alone takes up most of government spending. And now, with government having to borrowing at higher interest rates, interest repayments will be higher and borrowing will become more expensive.
In order to determine how best to handle the cost of borrowing, government will have to make a choice between cutting expenditure or increasing taxes to accumulate more funds.
We’ve been downgraded for a week now and all seems normal right? The true impact of the downgrade will be felt over time. Here’s a quick summary of what you may experience:
The rand may further depreciate, resulting in the price of fuel and imported goods and food to rise. This will push up inflation
Because of the increase in inflation, SARB will increase interest rates. This increase in interest rates could happen as soon as May, making credit more expensive
There will be less access to credit, as government will require funding from financial institutions
Higher taxes will be implemented next year
Government expenditure on social grants, education (resulting in the possibility of free quality tertiary education decreasing), health (the National Health Insurance will be put on a back burner), infrastructure, and actual debt will decline
With less access to funding, less business investment, and a possible reduction in business confidence, job creation will stagnate, as businesses will be cutting costs;
With the banks downgraded, bonds and bank shares have been priced lower. This will have a negative impact on pension funds;
Middle- and low-income households will be the worst affected and will have to tighten their belts further thanks to rising inflation and interest rates. As a result consumption of goods and services will decline leading to a decline in business profits;
And with all of this happening economic growth may decline further, which is already low at a 0.3 percent.
On a more positive note, the junk status rating has already been factored in. The impact of the cabinet reshuffle was similar to that of Nenegate, and Pravin Gordhan was seen as the only factor preventing the downgrade. This can be seen by the rand/dollar exchange rate. Perhaps this factoring in can be a sign that the dollar won’t depreciate to the lows of 2015. Furthermore, a recession (or crisis) may assist our economy. According to Drazen and Easterly (two popular economists), a crisis can induce reforms. Crises force governments to make the changes that need to occur. And let us be honest, we’ve needed strong reforms for many years. In addition, a weak rand will make our exports cheaper and improve our competition.
So now what? Mass panic? Leaving the country as fast as possible? A junk status is tough place to be. Majority of the time it places a country into recession and it takes, on average, 7 years to improve. But there are ways to recover, and as mentioned above we need strong reforms, although it may be a mammoth of a task. Over the past 35 years, 20 countries have been downgraded to junk status. Of these 20 only 6 countries have regained investment grade status. Before you start hyperventilating, let’s talk about how the country can survive. The South African government is going to have to implement economic and fiscal reforms to reduce external vulnerability. In addition, full cooperation between government and business (the elusive partnership) will need to happen, as some reforms may involve privatising state-owned enterprises and implementing austerity measures.
Privatising SOEs will be the right step in reducing government debt and its burden. As it stands, many SOEs are seen to be poorly governed, operationally inefficient, and utilising a significant amount of state revenue. By reforming our SOEs, policy uncertainty will reduce and confidence and trust will increase. Increasing transparency around governance will illustrate that SOE leadership is being politically independent and trustworthy. In addition, the handling of any incompetent works will be done in an efficient manner.
But what else can we do aside from economic reforms? It’s easy to call for the head of the snake. And let’s be honest, this downgrade was a result of President Zuma’s actions. Perhaps we should go even further and revise our economic and political system? We currently have a capitalist system at play. Capitalism, if you’re unfamiliar with the concept, is when capital goods (or factors of productions) are owned by private individuals or businesses. Workers produce goods for business owners. These business owners pay labour for their services and the business owners receive the profit. A good system ensuring economic growth. However, capitalism is also a system that leads to inequality. The rich get richer and the poor get poorer situation. Essentially, that’s the problem facing our country today: high income inequality and poverty. And what many protests focus on: redistributing the wealth to assist the have-nots.
Now here’s where you may get upset, if not already. Recalling Zuma and replacing him with another ANC member, be it Cyril Ramaphosa or Nkosana Dlamini-Zuma, or even someone from another political party may not create a significant change. The problem we have is corruption. Corruption has been occurring in the South African government from pre-democracy times and plagues many countries (not only African). A system that can thrive in a capitalistic society. Until we, as the citizens of South Africa, find a way to reduce corruption through mandating and enforcing transparency in government and business sector, swapping out one political leader for a lesser evil may not leave us better off in the long-run. Remember Animal Farm?
So what’s next? Interesting times that lay ahead for the country. More protests are likely to occur. Another downgrade from Moody’s may be on the cards. Zuma may go or remain. But perhaps the most important thing we should focus on is how government handles the downgrade and to hold them accountable for the downgrade. Because at the end of the day, you and your wallet are going to be the most affected.