Moody's downgrade: a close look

Several of our international Insight recipients have asked us to explain the reasons for and the effects of the recent (27 September) downgrading of the South African government’s bond rating from A3 to Baa1 by rating agent Moody’s. Although the downgrade, the first since apartheid, was widely reported in the South African media, there were very few reports which specifically spelt out the reasons for the downgrade. And, obviously, the reasons are of particular importance to investors.

The Moody’s statement said the key drivers of the downgrade included: "(1) Moody’s reassessment of a decline in the government’s institutional strength amidst increased socio-economic stresses and the resulting diminished capacity to manage the growth and competitiveness risks. (2) Shrinking headroom for counter cyclical policy actions, given the deterioration of the government’s debit matrix since 2008, the uncertain revenue prospects and the already-low level of interest rates. (3) The challenges posed by a negative investment climate in light of infrastructure shortfalls, relatively high labour costs despite high employment, and increased concerns about South Africa’s future political stability."

Moody’s explanation continued with: "The rating outlook remains negative because of the uncertainty surrounding critical policy decisions that will be made at the coming National General Conference of the ruling African National Congress (ANC) party in December. The ANC’s National Policy Conference (NPC) at the end of June left many such discussion topics unresolved. South Africa’s medium- to long-term political and economic stability depends crucially upon how well the Party is able to coalesce the ongoing policy discussions into concrete and effective decisions by that time."

These are abbreviated summaries of what the rating agency describes as the "main drivers" of its decision.

While media comment in South Africa was largely of the kind "rating cut is a wake-up call", the South African government through the National Treasury responded as follows: "All the reasons given by Moody’s for the downgrade are currently being addressed through various government programmes. Some of the drivers of the downgrade have their roots in the protracted crisis in the euro zone, South Africa’s significant trading partner. Government remains committed to taking the necessary measures to lift the growth potential and competitiveness of the South African economy. Accordingly government remains committed to the objective stated in the 2012 Budget."

Moody’s reasons need to be looked at more closely because they go to the fundamentals of South African society – present political leadership and the policies it has pursued; the morality and sense of vocation of a conspicuous minority within the newly dominant elite; and the exclusion of many, many skilled, experienced and committed South Africans from main-stream decision-making because of affirmative action.

In elaborating the main driver for the downgrade, Moody’s speak of the "lowered assessment of institutional strengths to moderate from high, an important fact in the rating agent’s judgement of a sovereign’s economic resiliency. The revision reflects Moody’s view of the South African state’s reduced capacity to handle the current political and economic situation and to implement effective strategies that could place the economy on a path to faster and more inclusive growth." It goes on to refer to the National Development Plan, which several Insights have referred to in favourable terms, as formulating "a comprehensive set of reforms meant to lead to increased development and reduced inequality." Yet, Moody’s notes "that the fractious domestic environment is not conducive to the reforms being implemented at present. An example is the protracted debate once again of the proposals to introduce the subsidy for younger workers, who face a 50% unemployment rate at June’s National Policy Conference." This is a seriously negative comment but we regrettably acknowledge that it is completely in line with views we have adopted over the past year. Moody’s statement also happens to coincide with sentiments expressed by the Governor of the Reserve Bank, Gill Marcus, yesterday. Marcus speaking at Rhodes University is quoted as saying: "South Africa’s economic outlook was worsening and job losses will mount as strikes spread. The outlook at the moment is deteriorating rapidly."

Does this downgrading mean that South Africa is to be written off? Not to be taken seriously from an investment point of view? That is not what Moody’s is saying and that certainly is not the conclusion we would wish anybody to draw. But the negatives raised by Moody’s need to be confronted and debated.

South Africa, after all, is the most diversified economy in Africa, contributing in very important ways to the rest of Africa through institutions like the Johannesburg Stock Exchange, the Development Bank, the Industrial Development Corporation, Transnet, Eskom, South African Agriculture and companies who meet middle-class needs in Africa. Also on the positive side are South Africa’s vibrant and robust institutions, its legal system, its Independent Electoral Commission, its Public Protector, its regulatory bodies, and Africa’s most vibrant media and most developed civil society, and a Constitution which has demonstrated that citizens have the right to take on the government and win in the highest Court of the land. An important positive is the encouraging growth in support from all communities for the Democratic Alliance, the main opposition party.

What also should not be excluded is the possibility of political change. Yesterday, in an Op Ed article in Business Day, Pallo Jordan, an ANC intellectual heavyweight, wrote under the heading "Wanted: a president to restore the ANC’s credibility." He concluded a very stimulating article with: "For many in the ANC, Jacob Zuma’s election promised relief from the managed internal democracy of Mbeki’s incumbency. Instead, it has been marked by political problems, most notably a radical decline in the ANC’s credibility. Zuma’s own actions have also stripped the office he holds of dignity. Whoever the ANC membership elects in December will have to grasp the nettle of restoring the ANC’s dented credibility and dignity to the office of the president." We say "Amen" to that.

Dr Denis Worrall is Chairman of Omega Investment Research

This article first appeared as a E-Letter from Omega Investment Research. Email This e-mail address is being protected from spam bots, you need JavaScript enabled to view it for more information.

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