In 1994 Moody’s was the only credit rating agency to grant SA a foreign currency credit rating with an investment grade, Baa3. This is equivalent to a BBB- from S&P and Fitch, whose initial ratings were BB and BB+ — one and two levels below investment grade respectively. Over the next 25 years the country’s credit rating improved to a best of A3 by Moody’s in 2009 and BBB+ by S&P and Fitch in 2005.
However, a combination of the global financial crisis-induced economic slump and outright domestic economic mismanagement has reversed all the hard work done to improve the country’s credit rating, sending the country back to 1994’s level of creditworthiness. Throughout this journey it has been clear that Moody’s has favoured SA, as its rating has always been higher than those of the other two agencies.
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The Moody’s credit rating review, which is expected after markets close todayMarch 29 on Friday, is arguably the most important credit rating review in the country's SA’s history because it is the last standing investment grade foreign currency credit rating. If the rating is cut this would mark the first time since the dawn of democracy where that Moody’s SA credit rating would be below investment grade, and where its SA’s ratings are sub-investment status all round. It will really be unchartered uncharted territory for the country’s financial markets.
On the basis of Moody’s’ recent statements and its methodology, with the latter differing from that of S&P in that it tends to look through the cycle and is therefore less reactive to short-term dynamics, I believe with 60% confidence that Moody’s will not change either its Baa3 rating or the stable outlook. This would be the best outcome under the circumstances, since it will spare SA the pain of macroeconomic adjustment following a downgrade to sub-investment grade.
Though not my base case, there is a chance that the stable outlook could be changed to negative, which will primarily be an assessment of weakness in fiscal strength for two main reasons. Firstly, no matter what financial engineering is possible in the restructuring of Eskom, the power utility’s debt is ultimately SA’s debt, so it can be viewed as a contingent liability on the state’s balance sheet.
Secondly, Moody’s may assess the rolling electricity load-shedding to be persistent and likely to negatively affect the medium-term economic growth outlook and therefore tax revenue collection.
If Moody’s takes negative rating action, a change in outlook from stable to negative while retaining the investment grade rating seems more likely than an outright downgrade, based on the agency’s rating historical trends. Usually, a negative outlook is resolved over an 18-month period, which will give the government some time to address Eskom’s balance sheet and restructuring. Another possibility is for Moody’s to put the country on review for a downgrade, which is usually resolved in three months and typically ends with an actual downgrade.
Over the past three weeks I have been on the road talking to clients and there was one consistent question: will Moody’s downgrade the country’s credit rating and, if so, what does it mean for the ordinary citizen?
Financial markets are already pricing in a credit rating downgrade. Five-year bond CDS spreads are trading at 213 basis points, 27 basis points higher than Brazil, which is already sub-investment grade. Estimates point to a potential increase in bond yields of up to 100 basis points and about 10% depreciation in the rand against the US dollar, as a sub-investment grade rating will trigger exclusion from the Citi world government bond index.
Offshore fund managers underweighted SA after the 2018 sell-off, so the impact will be less pronounced than many of the estimates floating around. An analysis of more than 20 countries that have been downgraded to sub-investment grade shows that both bond yields and currencies tend to recover over the 12 months after a downgrade.
The macroeconomic adjustment — economic growth and employment — varies depending on the policy response. Given the past 12 months’ policy actions, SA’s policy response is already on a positive trajectory. Even if we are downgraded to sub-investment grade in 2019 , it will not be the end of the world.
• Mhlanga is executive chief economist at Alexander Forbes.
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