Moody's
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  • Ratings agency, Moody's could strip South Africa of its investment grade rating tonight.
  • This means investors across the world will be forced to sell billions of rands of South African government bonds.
  • This could also have an effect on the price of bread and petrol. Even banks could be affected.
  • South Africa losing its investment grade is not the end of the world – other countries, like Brazil, have been junk for years.
  • For more stories go to www.BusinessInsider.co.za. 

The ratings agency Moody’s could strip South Africa of its investment grade rating tonight, which will downgrade SA to junk.

What does that mean?

If Moody’s “junks” SA, investors across the world will be forced to sell billions of rands in South African government bonds.

Currently SA government bonds are rated as “investment grade” and therefore included in the most important group of government bonds. The Citigroup’s World Government Bond Index doesn’t allow bonds that are junk. A “junk” rating means there's is a bigger chance that government won’t be able to pay back its creditors.

In 2017, after Pravin Gordhan was fired as minister of finance, ratings agencies Fitch and S&P decided South African bonds aren’t investment grade – and downgraded us to "junk".

CAPE TOWN, SOUTH AFRICA FEBRUARY 22: (SOUTH AFRIC
Former South African Finance Minister, Pravin Gordhan, addressing the media during a press conference ahead of the 2017 budget speech at Parliament on February 22, 2017 in Cape Town (Photo by Lulama Zenzile/Foto24/Gallo Images/Getty Images)

But SA government bonds remained in the index because Moody’s still viewed us investment grade.

If Moody’s also “junk” SA, our bonds will be kicked out of the index.

All the many overseas investment funds that track the index and are only allowed to invest in investment grade bonds will be forced to sell their South African government bonds. Some estimates reckon R200bn in bonds could be sold.

How will this impact you?

Higher petrol, bread and prices (potentially)

Most of the bonds foreigners will be forced to sell are held in rand, which means when they get rid of these rand-based assets, they will sell their rands to take their proceeds out of the country. This will put pressure on the rand.

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A weak rand affects everything, starting with fuel prices. Oil is South Africa’s biggest import. If the rand weakens, oil (which is priced in dollars) becomes basically immediately more expensive.

Imported electronics and machinery are pricier if the rand is weak. And South Africa’s maize and wheat prices are also linked to the global dollar prices.

Petrol price
Pixabay
Pixabay

But many experts believe the downgrade is already priced into the rand, and it won’t have a massive impact on the local currency.


Scaled-down government services and higher taxes

The bigger damage will be that foreigners will now demand a higher interest rate when the lend money to a “junk” South African government. This means government will have to pay more in interest, which means less money for services (healthcare, education etc.) and investments in infrastructure.

OSAKA, JAPAN - JUNE 28: (RUSSIA OUT) South African
South African President Cyril Ramaphosa speeches during a bilateral meeting at the G20 Osaka Summit 2019, June 28, 2019 in Osaka, Japan. (Photo by Mikhail Svetlov/Getty Images)

And as government has to pay more in interest on its debt, it will need more money from you to cover its basic expenses. This can only mean one thing: higher taxes.


Bad news for the banks and their customers (eventually)

The credit ratings of Standard Bank, Absa, Nedbank and FirstRand are all tied up to the rating of South Africa, where they make most of their profit. S&P downgraded seven local banks directly after it cut South Africa to junk. This means that banks have to offer higher interest rates when they borrow money. This means more pressure on them to get more money from clients, through higher fees and interest rates.

By law, banks are also forced to hold government bonds, which would have hurt them in case of a bond sell-off.

Not a done deal – and not the complete end of the world

In theory, Moody’s still needs to downgrade its outlook for South African debt rating from “stable” to “negative”, before it can “junk” the country.

Most economists don’t believe it will skip directly to “junk”, but may wait until next year’s Budget for a definitive decision.

What are government bonds?

A bond is basically an IOU, with the borrower agreeing to repay an amount plus interest. If a bond issuer is seen as riskier, investors will demand higher interest rates.

If South African bonds were rated as junk, government would have to pay higher interest rates. This means the state would have to pay billions more in interest, at the cost of investments in local roads, hospitals and services

Also, losing its investment grade is not the end of the world – other countries, like Brazil, have been junk for years.

Importantly, international investors are so starved of yield, they may still happily buy SA government bonds in a world where investors are paying some governments for the privilege of lending them money.

Yields on government bonds from ten countries – including Germany, the Netherlands, Japan and France – are now below zero. The yield on a government bond is the return investors will earn. A negative yield means that investors will lose money on their investment.

Meanwhile, the 10-year South African bond are now offering an eye-popping 8.2%.

Finance Minister Tito Mboweni extols the virtues of the Aloe ferox plant as he delivers his 2019 Budget speech in Parliament. (Gallo Images)

Still, any upward pressure on government debt cost will be a calamity.  Finance minister Tito Mboweni this week warned that the country’s debt-to-GDP ratio, which as recently as two years ago was at 50.6%, is currently 61% and will grow to above 71% of GDP by 2022.

"At the most, I hope (Moody’s) keep the rating where it is. But (…) it is not looking good," Mboweni warned parliament

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