On the evening of Friday 3 June, Standard & Poor’s (S&P) Ratings Service will release its latest review of the South African sovereign’s credit rating. Sovereigns are the national governments of an independent country who have control over state finances and management of their economy. To be clear, a sovereign rating does not assess countries and their economies, but rather the public entity charged with managing the country and is able to issue financial instruments.
In December 2015, S&P rated the South African sovereign “BBB-” (the lowest possible investment grade rating) with a negative outlook. The negative stance was largely associated with the fact that S&P believed that economic growth could underperform compared to its projections for 2016-17. Any downward adjustment in the country’s rating would place the South Africa government in non-investment grade territory, generally referred to as ‘junk status’.
Moody’s Investors Service recently commented that it sees the country’s economic growth gradually strengthening after reaching a trough during 2016, and S&P might have the same perspective on this issue when it decides whether South Africa should retain its investment-grade rating. However, in December last year, S&P listed other points of concern, including risks posed to the public sector balance sheet by struggling state-owned enterprises, a potential reduction in fiscal flexibility and an increase in external imbalances.
Analysts believe that the immediate fallout from a downgrade would see a weaker exchange rate, a decline in local equities, and a rise in government bond yields. According to a recent South African Reserve Bank (SARB) study of 70 countries, a downgrade to non-investment grade is likely to increase a sovereign’s short-term foreign currency borrowing costs by 80 basis points. Indeed, ratings have for decades played an important role in the pricing and marketing of fixed-income assets to investors.
If South Africa were downgraded to non-investment grade this week, how long would it take to regain its lost investment grade rating? Considering the sovereign ratings assigned by the three largest rating agencies – S&P, Fitch Ratings and Moody’s Investors Service – over the past three decades, 15 countries have seen their investment-grade ratings revoked but were then able over time to regain this status. These include (alphabetically) Colombia, Croatia, Hungary, Iceland, India (twice), Indonesia, Ireland, Korea Republic, Latvia, Romania, Slovakia, Slovenia, Thailand, Turkey and Uruguay.
The causes behind the rating downgrades are broadly grouped into four categories:
- economic deterioration (Colombia, Hungary, India, Latvia and Romania);
- unsustainable macroeconomic imbalances (India, Slovakia and Slovenia);
- a domestic currency, financial or banking crisis (Croatia, Iceland, Ireland, Thailand, Turkey and Uruguay); and
- a currency, financial or banking crisis resulting directly from neighbouring or regional influences (Indonesia and the Korea Republic).
These countries’ diverse experiences show that it takes on average seven years to again graduate to the investment-grade club. Countries like Croatia, Iceland, Ireland, Korea Republic, Latvia and Slovenia were able to do so in three years or less. At the opposite end of the spectrum, and depending on which rating agency was involved, there were instances where it took Colombia, India, Indonesia, Turkey and Uruguay more than a decade to do so.
Strategies and narratives on countries that recovered their investment-grade ratings are broadly grouped into six categories:
- fiscal consolidation and/or austerity (Hungary, Ireland, Latvia, Romania and Slovenia);
- significant economic and political reforms (Colombia, India, Indonesia, Turkey and Uruguay);
- declining external and fiscal vulnerabilities (India and Thailand);
- debt restructuring and economic policy reform (Korea Republic);
- privatisation of the sovereign’s holdings in private/semi-state companies (Croatia); and
- active intervention by a newly elected government (Iceland and Slovakia).
If South Africa loses its investment grade rating anytime soon, it will take many years to recoup this lost ground. And it will at the very least require concerted effort from economic and political leaders to do so. The road to recovery would, however, not be a smooth journey, and returning to an investment-grade position is no guarantee of maintaining this status. For example, Moody’s downgraded India to non-investment grade in 1991 and then upgraded it back to investment grade in 1994. Another downgrade from Moody’s to non-investment grade was seen in 1998 followed by an upgrade in 2004.
Christie Viljoen is an economist at KPMG South Africa.