- Moody's has decided that South Africa's government bonds aren't 'junk'.
- It is the only credit rating agency that has kept South Africa at investment rating.
- This has avoided a massive sell-off of South African bonds.
- It may result in a rate cut next week and a stronger rand.
The credit rating agency Moody’s has decided not to cut South Africa to junk status, averting a massive blow to the country. Moody's also changed its outlook for South African from 'negative' to 'stable'.
"The confirmation of South Africa's ratings reflects Moody's view that the previous weakening of South Africa's institutions will gradually reverse under a more transparent and predictable policy framework," the agency said. "The recovery of the country's institutions will, if sustained, gradually support a corresponding recovery in its economy, along with a stabilisation of fiscal strength."
Fitch Ratings and S&P Global lowered South Africa's credit rating to ‘junk’ in April 2017 after Pravin Gordhan was fired as minister of finance. If SA lost its investment rate grade from Moody’s as well, it would have cost the country its place in the most important group of government bonds. The Citigroup’s World Government Bond Index contains only bonds that are investment grade.
All the massive investment funds that track the index would have been forced to sell their South African government bonds. Bank of America has estimated that South African bonds would have been sold off to the tune of $14 billon (R167 billion). This would have lowered the value of our bonds, and make it much more expensive for government to borrow money to keep the country afloat.
A bond is basically an IOU, with the borrower agreeing to repay an amount plus interest. If a bond issuer is deemed as riskier, investors will demand higher interest rates. If South African government bonds were rated as junk, investors would have demanded higher interest rates. This means government may ending up paying billions more in interest, at the cost of investments in local roads, hospitals and services.
Retaining our investment grade rating, which SA has held since 2001, should mean the following:
1. The rand will get some respect
The local currency has been under pressure ahead of the Moody’s decision. A sell-off of government bonds would have meant a massive outflow of money out of the country. The announcement gives it some breathing space.
The rand strengthened by almost one percent to R11.72/dollar following the announcement.
2. Interest rates could be cut next week.
Given that the rand should remain relatively stable, this means that imported prices and inflation will be contained. Inflation has been within the committee’s target range for the last ten months, with consumer inflation down to 4.4% in January, the lowest reading in three years. This means that committee has some leeway to cut rates.
The Reserve Bank’s monetary policy committee will announce its decision on interest rates on Thursday.
3. Banks can breathe more easily
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.
By law, banks are also forced to hold government bonds, which would have hurt them in case of a bond sell-off.
The announcement should help support their share prices.
4. Further income tax and VAT hikes may be limited
If government has to pay more in interest on its debt, it will need more money from you to cover its basic expenses. In this year’s Budget, South Africans have been slapped with a number of tax hikes, most painfully a hike in VAT. Moody’s decision on Friday means that more hikes may be avoided.
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