Windhoek
Just as people and businesses have a credit rating at the bank, so too do countries. Countries are rated by independent credit rating agencies such as Moody’s, Fitch and Standard & Poor’s.
The purpose of credit ratings is simply to assist investors to make informed investment decisions.
When credit rating agencies evaluate a country they look at the possibility that the country, or its government, will be able to repay its debt. Countries or governments often issue debt instruments such as bonds and treasury bills and investors want to know if the government will be able to repay the debt on the day it expires.
This becomes even more interesting since companies, just like countries, also receive credit ratings, but a company’s credit rating can never be better than that of the country in which it is based. Thus, if a country has a low credit rating it follows that companies in that country will also receive a low credit rating score.
If you have a low credit rating, investors will be hesitant to invest in your company due to the uncertainty whether they will get their money back or not. If they are willing to invest with you, they will expect a much higher rate of return to compensate for the risk that the company may not be able to repay its debt. The established principle of the higher the risk, the higher the rate of return therefore applies.
So, why all the recent fuss surrounding South Africa’s credit ratings and its possible downgrade?
South Africa is on the brink of being downgraded in June this year. This won’t be just an ordinary downgrading. If South Africa is downgraded one more level, the country will reach “junk” status. This means that the ability and also South Africa’s willingness to repay their debt will at best be viewed with suspicion.
IMPACT
What will be the impact of a downgrade? Simply put, the interest rate at which the South African government and companies lend will dramatically increase.
Interest rates will also rise for the man on the street. This can lead to an increase in bad debts, insolvencies and even bankruptcies.
Another aspect is that a capital flight will occur. Investors are in many cases prohibited from investing in countries with a junk status credit rating and as a consequence will have to disinvest from South Africa.
The outflow of capital will over the short term drastically weaken the Rand which will have a knock-on effect with higher inflation and interest rates. Over the long term it will naturally have an immensely negative impact on the South African economy.
Likelihood
How likely is such a downgrade? If you look at economists’ expectations there is a substantial chance that our neighbour will be downgraded. However, our expectation is that the downgrade will not take place in June this year, but maybe at a later stage. It all depends on the market and politics in South Africa.
Therefore you should be on the lookout for a possible downgrade and stay abreast of what is transpiring in South Africa, since it can have the effect that your choices as a Namibian investor could drastically change.
• Fouché Brand is the Executive Officer for Private Clients at Capricorn Asset Management.