A further downgrade and what it means

By: Andrew Davison, Head of Investment Consulting at Old Mutual Corporate Consultants

On Black Friday, a day when consumers plan to go shopping in the pursuit of bargains and retailers traditionally expect to go into the black (i.e. tip from loss making to profitable for the year to date), South Africa received the latest assessment of its financial health by the global credit ratings agencies.

Following the previous downgrades by the three ratings agencies in early 2017, the latest ratings provided more cause for concern about the state of the South African economy. On Thursday night Fitch left their rating unchanged with a stable outlook. This was followed on Friday night by Moody’s who left their rating unchanged but with a negative outlook. S&P took the decision to downgrade both the local and foreign currency ratings.

The table below shows the current local currency credit ratings as well as the previous ratings of the three agencies. The (new) current rating is highlighted in orange (with the previous rating in grey). The blue shaded areas indicate unchanged ratings.

Table of local currency credit ratings

The Medium Term Budget Policy Statement seems to have been one of the triggers for this further downgrade as it essentially abandoned the policy of fiscal consolidation and portrayed a deterioration in the deficit and debt ratios yet indicated no cohesive plan to stabilise government’s finances.

The key for South Africans now is not to dwell on the downgrade. A downgrade by the ratings agencies is an assessment of our creditworthiness as a country. Although the downgrade does have implications for the cost of government borrowing and the ability to continue servicing existing debt, the downgrade itself is not the issue. Rather we should focus on the underlying problem, which is that our financial affairs as a country aren’t in good shape. To regain our status as an investment grade country we need to focus on how we can grow our economy, on each doing our bit to ensure that we are competitive in relation to other countries. This is critical in order to reduce the possibility of having to consider an IMF bailout in the future, as this may affect the State’s ability to pursue its developmental objectives.

Impact for investors
As always, it isn’t simple to predict the impact of these downgrades on various investments. The short term impact is sometimes quite different to the medium term impact. As a result of the fact that downgrades relate to our ability to repay our debt, bond markets are always impacted and this in turn affects the Rand. Bank shares are also often impacted because of the potential impact on interest rates. However, trying to react to events like this by switching or making changes to one’s investments is not advised and while it may be difficult to keep emotions in check, it is far better to stay focused on the long term objectives and leave it to the asset manager(s) to navigate your investments through this environment.

IMPORTANT CONSIDERATIONS FOR INVESTORS

Diversification
During times of heightened uncertainty like we are experiencing, it’s essential not to take excessive risks by investing heavily in any one investment. Spreading your investments across different types of assets that might react differently to the events as they unfold, will protect your savings from large fluctuations and hopefully allow you to ride out the volatility and any short term dips in values. Diversification ensures that you have exposure to growth assets like equities and property and not only conservative assets. These investments might feel risky but they offer protection against inflation, especially in the longer term. If your investment strategy isn’t sufficiently diversified then you should consider introducing some investments that are likely to behave differently to the ones you already have.

Global Bond indices
Unfortunately we are now a step closer to a removal of our bonds from the Citi WGBI (World Government Bond Index). It requires both Moody’s and S&P to rate our local currency debt as junk. This latest downgrade by S&P means all it will take is a one notch downgrade by Moody’s. If this happens it could lead to potentially large outflows from South African bonds (anything up to R140bn) as index tracking funds are forced to liquidate holdings of SA government bonds. Although this would have an impact, it is also important to remember that other global investors, those seeking higher yields among the countries that are sub investment grade, are likely to be buyers of our re-rated bonds so the net impact will be less significant. Indeed unconstrained active managers who recognise that yields may stabilise at lower levels may embrace the opportunity that these forced redemptions provide.

The Rand
As South Africans we are used to a volatile currency. The Rand may also be impacted by a weak economy and ratings downgrades as global investors allocate less money to South African assets and government debt grows. Although your ability to travel overseas or afford imported goods may be diminished by a weaker Rand, your offshore investments will benefit. This is why it’s important, as part of your diversification strategy, to allocate money to offshore investments too.

Improve your personal financial resilience
Irrespective of downgrades the South African economy is not in good shape. Downgrades are likely to make things tougher as they place additional pressure on government finances, which in turn trickles down to corporates and individuals. Building resilience into your own financial situation will make you able to withstand potential shocks. Things that you can do include saving more, in a short term, liquid investment that you can access in emergencies, cutting back on non-essential expenses, paying off debt and not taking out new debt.

Take advantage of the tax breaks available to you
One of the possible implications of the credit rating downgrades, compounded by the growing fiscal deficit facing South Africa’s government, is higher taxes. In light of this, taking full advantage of the tax breaks available to you is a sensible move. You can invest in a tax free savings account to shield your investment returns from tax. You can also contribute up to 27.5% of your salary towards a retirement fund (subject to a cap of R350 000 per year).

The bottom line
The South African economy is in a weak state. This is a tough environment and it is likely to give rise to increased volatility across most asset classes. It’s essential not to let your emotions interfere with your decisions in relation to your investment strategy. Remaining focused on the long term and resisting the urge to take action will most likely allow you to sail through the storm and emerge on the other side in a sound financial position. Importantly, don’t lose faith in your savings if they perform poorly from time to time, keep diligently allocating more money to savings and you’ll benefit over the long term from the ‘sale prices’ on any assets whose prices may have fallen.