3 June 2016
I have had several questions the past week or so on the chances of a rating downgrade by Standard & Poors (S&P), and what effect this will have on the ordinary South African.
I thought it would be good to give you my viewpoint on this.
On the chances of a downgrade...
Finance Minister Gordhan says he believes enough has been done to avert a downgrade.
I believe he may be right - for now.
My gut feel is that the Ratings Agency will give him 3 months' grace to see whether there is some follow through on what promises and commitments have been made.
But long term, I am not nearly as confident.
If Gordhan had the full backing on these undertakings from all those that should be doing so, including the Prez and his self-serving cronies (not to mention his expensive-new-car-loving wives), it would give the rating agencies and the international community a tad more confidence going forward.
On the effect of a downgrade...
What if it happens?
A downgrade will, of course, be negative for all South Africans...
I believe there are four areas that need to be looked at here in terms of the effect on ordinary South Africans - the effect on
- Interest rates
- The exchange rate
- Global investor confidence
- Long-term foreign business/investment
Of these four, the biggest concern should be the long-term effect on international business and investment.
This is because there are large multinationals that are not permitted to have a presence or do business in non-investment grade countries, and this will have a seriously negative impact on the economy and growth going forward if a downgrade does occur.
With the economy teetering on the edge of a recession, this is something we can ill afford.
There are also international investment funds that will not invest in non-investment grade stock and bond markets, but it is very likely that these have already taken a position on this.
In respect of interest rates, if you look at government bonds, a downgrade is already priced into the yields - in fact, South Africa's bond rate is higher than Russia, who have already been downgraded to junk.
While it could push interest rates higher, it does not look at this stage like it will be considerable.
On the exchange rate, this is an animal of its own.
As we have seen the past few months, the Rand will often do exactly the opposite of what we would normally expect. Moody's decision last month to keep its rating on hold is a prime example -
Irrational, yes, but the cause is that the Rand is driven by sentiment - not by events themselves, but persons' reactions to these events, based on their emotions at that time.
We saw the Rand hit an extreme of negative sentiment in January, and while there is the chance of some further near-term weakening, it still looks like we need some further Rand strength before the next weakening cycle begins.
Investor confidence - I have basically covered this.
Confidence is low - very low. But as mentioned above, it would seem foreign investors have largely priced in a downgrade to junk status already.
Make no mistake - a downgrade is not good news at all, and it will have an effect on growth here.
But financial markets themselves are irrational things and most often do the exact opposite of what everyone expects. With such is extreme negativity, there is almost no-one left to turn negative and push the markets weaker at this stage.
Expect a humdinger of a day, with US Non-Farm Payrolls announcement at 2:30pm (SAST) and then the awaited "execution or stay thereon" expected to be announced by S&P between 6 and 7pm.
Hold on tight - this could be a rollercoaster ride!
To your success~