The Moody Blues

International credit rating agencies have had a torrid time since 2008. They have been partly blamed for the global financial crisis because of the inappropriate ratings they granted to the mortgage-backed securitised assets that were at the heart of the crisis, resulting in the accuracy and credibility of their rating models being questioned.

Rating agencies have not endeared themselves to European policy makers, who have at times accused them of precipitating the European sovereign debt crisis by the (unwarranted) downgrading of the debt of member states of the eurozone. And in perhaps their biggest faux pas, Standard & Poor’s did the unthinkable by depriving the US of its AAA rating at a time when confidence in the US was already at a low.

No wonder policy makers have their knives out for the rating agencies, wanting to regulate their rating methodologies, suspend ratings when they are deemed to be unhelpful, and in general reduce their role in financial markets.

The downgrade of South Africa’s rating outlook from stable to negative by Moody’s and the dismissive response of the South African government to the decision are best interpreted within this context. Have Moody’s overstepped the line, or is it a case of “shooting the messenger” because of the discomfort his message causes?

Perhaps Moody’s made a mistake similar to that of S&P in the case of the US in so far as its decision to downgrade South Africa is mainly based on political arguments, which will always be a matter of subjective judgement and therefore susceptible to controversy. While S&P responded to the dysfunctional nature of American politics, Moody’s is in effect concerned with the blurring of the lines between party and state in South Africa. Perhaps it should have stuck to the numbers, which would have forced its critics to be equally analytical in their counter-arguments.

In my opinion, Moody’s decision could arguably have been justified on the basis of the trend in important fiscal parameters alone, without recourse to political arguments. Readers may refer to my commentaries of 11 and 26 October on South Africa’s fiscal position in the context of the Medium-term Budget Policy Statement, in which I expressed my concern regarding the trend in important fiscal parameters.

When Moody’s makes the point that South Africa’s fiscal management had been effective for more than a decade, it probably has mainly the period from 1996 to 2008 in mind. During this period, the budget balance swung from a deficit of 5,1% of GDP to a surplus of 0,9%, gross government debt declined from 50% of GDP to 27%, and the net foreign open position improved from -$22 billion to $33 billion. With the exception of the latter (currently $50 billion), we have witnessed a rapid deterioration in the fiscal variables since then, which Moody’s acknowledges as justifiable due to the need for expansionary fiscal policy in response to the recession.

In my view Moody’s is actually rather lenient in accepting this deterioration at face value, without noting that it was accompanied by a sharp increase in recurring current expenditure, including an explosion in the public sector wage and salary bill, which can hardly be described as anti-cyclical in nature and will be impossible to reverse.

Instead of casting the nationalisation debate in a political context, Moody’s could merely have pointed out its potential fiscal implications (see my commentary of 31 August 2011). Instead of emphasising the threat of populism to government expenditure, Moody’s could have pointed out that the assumption of the wage and salary bill increasing by 5% p.a. over the course of the medium-term expenditure framework lacked credibility in view of the experience of the past three years and the warning by public sector unions that they will not accept below-inflation increases. It could have highlighted the lack of fiscal space to accommodate South Africa’s infrastructure needs. It could also have referred to the financing needs of the proposed National Health Insurance system.

It could likewise have spelled out in detail the consequences for government revenue, the budget balance, and government debt of Government’s rather optimistic growth forecasts not being met.

To summarise, in view of my own concerns regarding the fiscal outlook I have some sympathy for Moody’s decision to downgrade its outlook for South Africa from stable to negative. I have commented on numerous occasions in the past that to my mind the National Treasury’s grip on South Africa’s public finances is slipping. It would serve us well to heed the message embedded in this downgrade, as unpalatable as it may be, to acknowledge the mistakes of the past three years and to restore fiscal discipline.

We should remember that credit ratings are relative measures, expressing an evaluation of an institution’s credit risk compared with its peers, and the unfortunate truth is that relative to its rating peers South Africa has experienced a sharper deterioration in its fiscal position since 2008. This is in spite of the country experiencing a relatively moderate recession in 2009, with real GDP being back to its pre-recession level by 2010. The table below tells the story.

Source: MTBPS October 2011, IMF Fiscal Monitor, September 2011

But perhaps we need to be less sensitive about Moody’s outlook downgrade. It does not entail an actual downgrade yet, but it is a warning that should certain negative developments which it regards as not improbable materialise, the fiscal implications will cause it to reduce South Africa’s rating at some future point in time. It is up to us to prove Moody’s wrong.

Furthermore, one should bear in mind that there are two specific rating levels that play a critical role in setting investment mandates, viz. AAA and investment grade. The first is not applicable to South Africa, and as for the second, we are a long way from being downgraded to junk-bond status.