Fitch’s Lowered Outlook, And Why South Africa Can’t Ignore Credit Ratings

Fitch’s Lowered Outlook, And Why South Africa Can’t Ignore Credit Ratings

Credit ratings agency Fitch revised its outlook for South Africa from stable to negative, citing political risks, standards of governance and policy-making, but kept its BBB rating intact, Eyewitness News reported.

Moody’s, another of the Big 3 Wall Street credit ratings agencies, was also expected to release its outlook on Friday, but as of 4 p.m. EST, had not done so.

The credit ratings agency market is dominated by Moody’s Investors Service (Moody’s), S&P Global Ratings(S&P) and Fitch Ratings (Fitch). All are based on Wall Street in New York City, and they control more than 95 percent of the sovereign ratings market.

There are about 70 rating agencies globally, but most investors base their investment decisions on the credit ratings published by Moody’s, S&P and Fitch, according to Mampho Modise, a University of Pretoria researcher affiliated with the South African Treasury.

What good are credit ratings agencies anyway?

Rating agencies have assess the performance of key macro- and socioeconomic indicators that determine a borrower’s creditworthiness — its ability and willingness to honor debt obligations — in this case, South Africa.

When reviewing the sovereign ratings, rating agencies talk to stakeholders in government, labor, civil society and the private sector. The private sector is included to get an independent view on government policies and strategies.

South Africa can’t afford to ignore the Big 3 credit ratings agencies, Modise said in a guest column in The Conversation, especially since foreign investors hold more than 30 percent of government debt.

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Taking on the Big 3 credit ratings agencies

South Africa and fellow BRICS trading allies — Brazil, Russia, India and China — have discussed setting up a credit ratings agency of their own. Those talks recently hit a roadblock after China said it was not in favor.

India first raised the idea of a BRICS credit ratings agency to solve impediments for emerging market economies posed by the present credit ratings agency market dominated by S&P, Moody’s and Fitch, Indian Express reported.

Indian officials pointed out shortcomings and the need for an alternative credit ratings agency. China expressed concern about lack of credibility and access to dependable data as they take on Wall Street’s Big 3.

Fraud charges against South African Finance Minister Pravin Gordhan raised fears the country is moving closer to a junk rating by Wall Street credit ratings services.

The fraud charges have since been dropped, but they overshadowed the government’s efforts to boost investor confidence, Mail & Guardian reported. Gordhan tried to stave off a downgrade while squabbling with President Jacob Zuma over the management of state-owned companies and the South African Revenue Service.

Fitch listed a number of issues including political risks, standards of governance and policy-making. Political risk is a key ratings driver, Fitch said Friday in a statement.

South Africa’s 2016 GDP growth of 0.5 percent is expected to improve, growing to 1.3 percent in 2017 and 2.1 percent in 2018.

In December 2017, the governing African National Congress (ANC) party will elect a new party leader to be its 2019 presidential candidate. Political risks to standards of governance and policy making have increased in South Africa and will remain high at least until the ANC electoral conference of 2017, Fitch said. The high political risk negatively affects macroeconomic performance.

“The in-fighting within the ANC and the government is likely to continue over the next year. In Fitch’s view, this will distract policymakers and lead to mixed messages that will continue to undermine the investment climate, thereby constraining GDP growth.”

Fitch also said allegations of undue influence in government procurement processes, contained in the Public Protector’s State of Capture report, underlined the risk of the governance of state-owned Enterprises and resulted in the resignation of Eskom CEO Brian Molefe.

“The South African economy may have started recovering from a series of shocks, but business confidence remains depressed and investment has continued to contract,” Fitch said.

“The Fitch decision to revise the outlook on South Africa’s BBB- rating is negative, as it brings South Africa closer to a potential downgrade to sub-investment grade,” said Razia Khan, head of Africa macro research at Standard Chartered, Mail & Guardian reported.

Moody’s was expected Friday to release the review of its credit rating, which was at two levels above junk with a negative outlook. S&P Global Ratings, which assesses South Africa’s debt at the lowest investment-grade level with a negative outlook, plans to publish its report on Dec. 2.

A poor credit rating suggests that the borrower has had trouble paying back loans in the past, and might follow the same pattern in the future, Modise said. Here’s why he said credit ratings are important to South Africa:

Firstly, investors use credit ratings as a guide to their investment decisions. Credit ratings provide an independent and objective assessment of the creditworthiness of countries and corporations. This assists investors to decide how risky it is to invest money in a certain country or corporation.

Secondly, for corporations and governments who want to raise money in the capital market, a favorable rating means a country will be able to obtain funds at a lower cost.

Lastly, governments could also use credit ratings as a measure for gauging their performance relative to peers to effect improvements.

Do the agencies operate in every country around the world?

Not necessarily. Rating agencies can operate unsolicited. But major rating agencies such as Moody’s , S&P and Fitch are solicited by countries to provide credit ratings.

Moody’s operates in 36 countries, S&P in 28, and Fitch in more than 30 countries.

What happens to a country downgraded to junk status?

Junk status is associated with high risk, therefore high borrowing costs. This is the main reason why a sovereign has to avoid being downgraded into a junk, or sub-investment grade.

For fund managers (who are representing the investors) a downgrade to junk status means they will have to sell the assets (bonds) they hold. Their mandates require that they only invest in investment grade assets.

For an ordinary person it means paying more interest, leaving little money for savings and expenditure on rent, school fees and food.

For governments it means allocating more to debt-servicing costs (interest payment). Less money will be available for social grants, investment priorities, creating jobs and ultimately reducing the GDP growth potential of the country. More interest payment also crowds out other critical spending. Social services is an example.

Is it possible for a government to simply ignore their ratings?

Not really. Solicited credit ratings ensure easy access to international capital markets. Favorable credit ratings imply low borrowing costs. The South African government has solicited credit ratings from the top agencies to ensure that it can easily and cheaply access foreign funding needed to accomplish its economic development agenda.

South Africa therefore can’t ignore the credit ratings assigned to it, especially given that foreign investors hold more than 30 percent of government debt.

Which agency is taken most seriously?

Sovereign credit rating is the most concentrated industry. There are approximately 70 rating agencies globally. But most investors base their investment decisions on the credit ratings published by Moody’s, S&P and Fitch. These three control approximately 95 percent of the rating business.