The Moody’s Mystery
We often hear about ‘Moody’s ratings’, but what are they really and what implication will a downgrade in this rating have on South Africa? Of late, words like “junk status” and “downgrading” are floating around inside South African vocabulary, as the economy waits for Moody’s rating verdict to be given after the budget speech in February 2020.
Moody’s is one of the world’s most widely used credit rating and risk analysis companies, due to their worldwide-respected reputation of independence and integrity. Foreign and local investors use the ratings which Moody’s publishes on companies and country credit-research, to make sound investment decisions. These types of credit ratings often guide which assets investors place their confidence in, in different countries across the world.
The Moody ratings are broken up into two main sections ‘Investment Grade’ and ‘Non-Investment Grade’ ratings:
These ratings are determined based on the company/country’s ability to repay debt in the short term and the long term, as well as the financial strength of a country’s bank. South Africa’s rating is clinging onto the lowest ‘Investment Grade’ rating, Baa3. This means Moody’s is forecasting that it will be highly unlikely that the country’s government will be able to repay its debt obligations.
How are country ratings determined?
Just like companies have accounting books to monitor their inflows, outflows, profitability, expenditure and growth- countries do too. Countries however do it on a much larger scale, with many more factors to take into consideration. A country can generate income over multiple revenue streams through its different sectors like: financials, industrial, mining, agriculture, technology, commercial, as well as imports and exports, investment portfolios etc. Like companies, countries also have running costs and expenditures.
Once a year, a country’s budget speech is presented to the nation, this discloses the financial health of the country. In essence, it is opening the countries ‘books’ to the public and tracking all the inflows and outflows managed by the government. From this, Moody’s will analyze the financial state of the country’s economy, politics and likelihood for government to repay its debts. From here they assign a rating. This rating largely influences the confidence that foreign and local investors have toward that country, its assets and its economic growth.
South Africa’s history with Moody’s ratings.
For the past 25-years, South Africa has been receiving an “Investment-Grade” rating from Moody’s for government bonds. Over the last two years, two other major rating companies have rated South Africa’s government bonds at “Non-Investment Grade” or “Junk Status”. If Moody’s decides to follow in downgrading South African bonds, the nation can stand to suffer huge financial consequences.
After the countries budget forecast announcement in November 2019, South Africa is showing itself to be deteriorating financially, and fast. Despite this, Moody’s reviewed their outlook on South African bonds and held back on downgrading government debt to junk status. This surprised most, because the country’s budget forecasts were looking pretty bleak. Moody’s has granted South Africa 3-months to get its finances in order and put strategy in place, before they review their verdict again. South Africa is not in the clear just yet, as many investors are anticipating for Moody’s to downgrade to “junk status” after February 2020.
After Moody’s released this statement, South Africa’s Finance Minister, Tito Mboweni, replied by saying; “The country needs tough reforms to fix its fiscal problems and debt-laden state companies like Eskom Holdings SOC Ltd.”
Eskom is simultaneously one of the largest detractors and contributors to the South African economy. The government is spending about R280 billion to bail Eskom out of the R450 billion worth of debt it finds itself in. On top of this massive lumpsum cost to state finances, the regular power- blackouts are causing economic contractions. To date, this has slowed economic growth forecasts to 0.5% for this year.
Moody’s has rated Eskom’s long-term debt at B2, we can see that this is “Non-Investment Grade” and that Eskom is highly unlikely to be able to repay the debt they owe the South African government. That means the power utility has to rely on government guarantees to borrow in capital markets, increasing the strain on state finances.
Moody’s is not the only one holding this opinion of Eskom’s position. Cristian Maggio, London-based head of emerging-market strategy at TD Securities, said in a report after Novembers budget release; “From a rating agency’s perspective, this means only one thing: The debt trajectory is unsustainable over the long term.”
Gina Schoeman, an economist at the Wall Street bank commented that a Moody’s downgrade for South Africa is highly probable if they fail to come up with a “credible debt-stabilization strategy, which will involve tough negotiations between the government and unions about reigning in spending.”
What would happen to South Africa if Moody’s decides to cut?
A downgrade will cost the country its final ‘Investment-Grade’ rating. This would take place if the country is rated anything below Baa3 on the Moody’s rating table. Shifting the status from the ‘Investment Grade’ category to the ‘Non-Investment Grade’ category.
What implications does the “Non-Investment Grade” category have on South Africa:
- South Africa will be excluded from the FTSE World Government Bond Index. The FTSE World Government Bond Index is a tracking index which has about $3 trillion in its investment portfolio, according to the Bank of New York Mellon. South Africa holds about a 0.45% weighting inside this index. If we get downgraded, we lose our investment-grade rating and are disqualified from being included in the index. This alone would trigger outflows of about $15 billion from the rand-bond market.
At this point in time the country is somewhat reliant on investments like this as capital inflow. It is currently a form of inflow into the country and is valuable in order to finance South Africa’s current-account deficit, largely due to Eskom. South Africa currently holds one of the largest deficits among major emerging markets.
- The downgrade would also increase borrowing costs and in turn it would become even harder for the South African government to try balance the country’s budget.
- Downgrading could also change the profile of South African assets for investors.
Leila Fourie, chief executive office of bourse operates the Johannesburg Stock Exchange (JSE) Ltd, stated that if the downgrade happened “It will change the type of investor from a buy-to-hold, pension fund type investor to a more speculative hedge-fund-type investor”. This is a more complex, derivative type investment style.
- Bloomberg data suggests that there has already been an implication in foreign investor confidence toward South African assets. Already we have seen foreigners sell $6 billion (R90 billion) worth of stocks this year on the JSE. Further loss of confidence in South African assets can also be seen in the pricing of JSE listed companies.
South African bonds are yielding well at present
Currently, when comparing South African bonds to global, global bonds are yielding negative where, Phoenix Kalen an analyst at SocGen, London, stated: “South Africa’s local-currency bonds stand out with elevated real returns being offered. Over the short-term horizon, investors may be tempted to hold South African assets for the carry they bring”.
To read more on bond investment in South Africa, please click here.
– Kheara Kroggel