It is unclear whether Standard & Poor’s (S&P) will cut South Africa’s credit rating to sub-investment grade when they announce their review next Friday. Assessment teams from both S&P and Fitch have been reviewing South Africa’s credit rating since last week, and expectations are that they might opt to delay a downgrade until December.
Our view is that a December downgrade is a live possibility. Our view is backed up by the heightened political risk and low growth environment in that country. Political risk and low growth have been two of the reddest of flags that ratings agencies have consistently raised. There have been assertions by local pundits that the impeding credit rating downgrade in South Africa would create instability in Namibia’s financial system. These assertions are both reckless and factually inaccurate.
While the risks associated with a credit ratings downgrade cannot be downplayed, there can be no place for scaremongering on baseless facts. But before delving into the risks associated with a sovereign credit rating downgrade, it is important to discuss what’s at stake. The most important thing to note is that South Africa’s credit rating on its sovereign foreign currency denominated debt is at risk of being downgraded to sub-investment grade by at least one credit ratings agency this year. That means that a downgrade, which has largely been priced into South Africa’s credit default swap spreads, will affect the foreign bond holdings and not necessarily the country’s domestic (ZAR-denominated) bond holding, which will in most likelihood retain its investment grade rating.
But while a downgrade has largely been priced into the financial market, the effects on the real economy are harder to ascertain. A recession would probably be inevitable following a ratings downgrade. A downgrade can be staved off if there is a dramatic about-turn that requires political will and an improvement in the government’s fiscal position. That can only be achieved with considerable political buy-in and a major review of government policies, but with the current crop of political leaders in South Africa at the moment it’s easier said than done.
What is promising is that government finances appear to be stabilising, but doubts obviously linger. S&P has South Africa’s credit rating just one notch above sub-investment grade and on negative outlook, while Fitch has the same rating, but on stable outlook. Fitch is also due to announce its ratings decision in June. Earlier this month, Moody’s kept South Africa’s rating unchanged at Baa2 with a negative outlook, still two notches above sub-investment grade. Should South Africa’s sovereign foreign currency denominated debt be downgraded to sub-investment grade by S&P this year, Namibia’s would not necessarily be impacted purely on a technical point. Namibia does not hold an S&P credit rating.
Namibia will be able to hold on to its investment grade rating in the short to medium term should South Africa be downgraded to sub-investment grade by Fitch. But we can’t foresee a scenario where Namibia, with its close and deep financial ties to South Africa, can maintain a credit rating above South Africa’s, should South Africa be sub-investment graded by either Fitch or Moody’s. But assertions that a South African downgrade will cause financial instability in Namibia is completely unjustified and not backed up by facts.
Let’s not forget that Namibia is also not immune to a downgrade. The country has its own frailties – a quick look at government’s finances might easily justify a downgrade. In the age of incredulity, it is essentially a wait and see game. Lest we also forget the role that rating agencies played during the last global financial crisis.
- Suta Kavari is an Investment Strategist at Capricorn Asset Management, which form part of Bank Windhoek Holdings.