On 27 March 2020, the last of the three major ratings agencies announced its downgrade of South Africa’s sovereign credit rating to ‘Ba1’. This downgrade rendered South Africa’s sovereign credit rating as non-investment grade. On 3 April 2020, two of the three major ratings agencies downgraded the major South African banks’ credit ratings to ‘BB’ and ‘Baa3’ respectively (due to their overall sovereign exposure).
Major implications of the ratings downgrades
The South African government needs to borrow money to bridge the gap between government expenditure and the taxes raised to finance that expenditure. South Africa’s lower sovereign credit rating will make it more expensive for the government to borrow money because lenders will judge it as being at greater risk of defaulting. Accordingly, the South African government will need to dedicate a greater portion of its revenue to interest payments, which leaves less to spend on social services such as education, healthcare and social grants, and on building and maintaining infrastructure.
As a result of South Africa’s sovereign credit rating downgrade, South Africa’s government bonds will be removed from global indices such as the World Bank Government Bond Index (WGBI). This will be delayed until the end of April 2020 due to the liquidity challenges and increased volatility in global markets that has resulted from the COVID-19 pandemic. However, fund managers with mandates that limit them to investing in investment-grade assets will inevitably be forced to sell South African government bonds. The capital outflow has resulted – and will likely continue to result – in the Rand depreciating against other major currencies. South African government bonds at significantly higher rates than comparative instruments in developed countries will nevertheless be considered by some as a good investment.
The ratings downgrades as a catalyst for structural reforms
The ratings downgrades coinciding with the COVID-19 pandemic has been a double blow for South Africa. However, National Treasury noted that this gives South Africa ‘an opportunity to do the things we are supposed to do’ to start fixing South Africa’s economy. The ratings downgrades have also encouraged President Ramaphosa to give Finance Minister Mboweni the political space to pursue much-needed structural reforms. President Ramaphosa has noted that these structural reforms will need to go hand-in-hand with a new social compact between government, the public and private sectors, and labour. Mboweni has noted that these structural reforms must not only be about the high-level fiscal and monetary variables but must also be about people, particularly the poor, infirm and vulnerable, businesses – large and small – that drive the economy and create work, and the banking system (to make sure that money continues to flow through the economy).
What structural reforms are needed?
The objectives of the structural reforms should be to stimulate growth, create resilience, protect the vulnerable and preserve jobs. Although there has been no definitive statement as to exactly which structural reforms need to be undertaken, it seems likely that they will revolve around the following themes:
- Fiscal balance is essential for growth and resilience.
South Africa needs to start running surpluses and building reserves. Fiscal policy sets the parameters for monetary policy. A fiscal policy that targets the correct savings/investment balance, will allow monetary policy to target macro-economic stability at a lower real interest rate.
- Having a consumption-driven economy and relying on inflows of foreign capital does not provide a solid basis for long-term growth.
South Africa needs to become less reliant on foreign capital inflows to finance public and private consumption above the productive capacity of the country. This reliance has made South Africa vulnerable to adverse global events and has increased economic volatility in South Africa. An investment body – privately run but backed by government – should be established to promote and co-ordinate foreign capital inflows.
- Export expansion and diversification are the main drivers of long-term growth.
South Africa needs to move from a consumption driven to an export driven economy. Export driven growth is how almost all developed and late-developing countries have climbed the income ladder. Export driven growth can be based on the export of sophisticated products, or on the export of efficiently extracted and processed raw materials. To achieve export-driven growth, South Africa needs to create the necessary infrastructure (reliable electricity supply and low logistical costs) and implement the necessary industrial policies and regulations. Eskom and Transnet must be overhauled and the energy market should be opened to independent power producers. Any non-core SOEs should be closed or sold to interested private buyers. Labour law and policies must also be negotiated to ensure that they are not hindering the ability to operate cost-effectively. Small businesses should be exempt from collective bargaining agreements (concluded between trade unions and large corporates) and start-ups should be assisted by subsidy schemes and incentives (including tax holidays and further labour law exemptions).
- Productive government investment in education, healthcare and infrastructure is also vital for growth and resilience.
South Africa needs to invest more productively and efficiently in all three of these sectors (significant investment in these sectors has been made in the past, but with limited real return). South Africa needs to combat any rent-seeking in the public and private sectors by limiting monopoly power and corruption, promoting innovation and competitiveness, and increasing accountability and transparency. The public sector wage bill must be reduced and any remaining SOEs should be restructured to minimise unnecessary or wasted expenditure on their part.
The professional services sector will play an important role in bringing about these reforms.