In a significant development for South Africa, the credit rating agency Standard and Poor's (S&P) downgraded South Africa's credit rating to "junk" status. This article delves into the implications of this downgrade, its potential effects on the South African economy, and the broader context of credit rating agencies in Africa.
The Downgrade: A Closer Look
On April 3, S&P lowered South Africa's credit rating by one notch to BB+, which is its highest non-investment grade mark, often referred to as "junk" status. At the same time, the agency assigned a negative outlook to Africa's most industrialized economy.
Fitch now downgrades South Africa credit rating to junk status
S&P explained its decision: "[t]he downgrade reflects our view that the divisions in the ANC- led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk".
Within hours of S&P's announcement, Moody's placed South African government debt on a review for a possible downgrade: "[c]hanges within a government do not generally signal material changes in a country's credit profile."
What Does "Junk" Status Mean?
A downgrade to "junk" status signifies that a country is perceived as a defaulting risk because it may struggle to repay its debts. As a result, investors demand higher compensation for the risk they undertake, which is reflected in a risk premium.
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Credit ratings are important as they are seen as a confidence barometer in a country's economy.Credit ratings agencies have played a crucial role in assessing the ability of governments, financial institutions and corporations to pay up on time, and in full. These institutions have a major influence on investor perceptions of credit risk.
Potential Economic Consequences
The downgrade to junk status can trigger a cascade of negative economic effects:
- Weaker Rand and Higher Inflation: A weaker rand means that inflation will rise. The raw ingredient of petrol - oil - is bought in dollars‚ so when the rand weakens‚ oil prices rise and so does the petrol price. Food is traded on international markets in dollars. The prices of rice‚ maize‚ sunflower oil‚ wheat and sugar are set in dollars. A weaker rand means we pay more for food‚ especially if it is imported.
- Increased Interest Rates: Interest rates are likely to increase, and South Africans will, therefore, have to pay more to repay their debt. The South African Reserve Bank often hikes the repo rate in response to higher inflation and as a measure to dampen inflationary pressures. This leads to banks also increasing their interest rates. As the economy weakens, lenders will increase interest rates because of a perceived greater risk in default. Debt has just become more expensive.
- Higher Borrowing Costs for Government: Government borrows almost monthly to pay its bills, as it spends more than it earns. Junk status ultimately means it will pay much more to borrow money and will be faced with two choices: to cut spending or increase taxes to cover the extra costs spent on debt. The cost of interest on government debt was ZAR128 billion or 3.2% of GDP from April 2015 to March 2016; S&P expects this to rise to 4.25%.
- Reduced Investment: Since many institutions, such as banks, are not allowed to invest in junk status debt, government will be forced to borrow from whose willing to invest in higher risk debt. These corporations and individuals will be less able and increasingly less willing to invest their money in South Africa. The downgrade will lead to a steep erosion of already poor levels of investor confidence, and perceived high risk will scare away future foreign investment. International investors will pull their money out of South Africa.
- Decline in Asset Values: The immediate effect is a drop in the value of equities and bonds, while the rand depreciates. The result - a decrease in the value of all South Africans' savings, investments and pension funds. Furthermore, many local and foreign investment funds that invest pensions or savings into debt are not allowed to do so where a country has junk status.
- Potential Emigration: It is foreseen than many South Africans may emigrate to pursue their goals elsewhere.
Opportunities Amidst the Challenges
Leading economist Dr. Azar Jammine stated that one of the opportunities created by the current economic situation is the export market, because inflation has not picked up sharply and, therefore, costs are rising at a slower pace. It is hoped, therefore, that the downgrade to junk status will not be only doom and gloom.
S&P has indicated that the downgrade to junk status means that economic growth and fiscal outcomes will suffer. Research reveals that on average, it takes approximately seven to eight years for a country to recover from a downgrade.
The Debate Around Credit Rating Agencies
Credit rating agencies have faced criticism from various quarters:
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- European Perspective: Many European politicians believe that credit rating agencies are biased against European countries or in favor of large corporations.
- American Perspective: Many American scholars believe that Big Three folks are purveyors of perfidy, snake oil charmers, and assorted other undesirable things. Accusations that they are to be to be blamed for the 2008/2009 Global Financial Crisis are widespread.
- Asian Perspective: In the Asian context, credit rating agencies have been blamed for exacerbating the 1997-8 financial crisis. There is constant wailing that the Big Three simply do not “get” Asian business. And, of course, the “political bias” lamentation is never far off.
The subjectivity that attends rating analysts’ use of discretion when factoring in qualitative, fuzzy, measures in rating decisions relating to borrowing countries’ institutional quality, political economy, “willingness to pay”, and governance capacity has been empirically shown to be significant. For some critics, the doorway to bias has, thus, been clearly framed.
Considering that the geopolitical segmentation of ratings agencies has been a thing for a while now, it is not surprising that some observers claim to have found evidence that each region’s rating agencies are biased against countries and corporations in other regions when they issue ratings.
The Case for an African Credit Rating Agency
A growing chorus of African experts have doubled down on the Big Three bias issue and insist that only a dedicated African Credit Rating Agency can save the day. They do not accept that studies purporting to find no such bias are methodologically comprehensive.
Some of these African Big Three critics cite work by scholars that show that data practices at the Big Three could be much improved; and that the resulting mispricing of risk has huge economic implications.
In the end, however, the real hurdles in the way of the African Union and its partners in the proposed “new African Ratings Agency” venture are practical.
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Challenges in Establishing an African Credit Rating Agency
Setting up a new continental credit ratings agency won’t be cheap. It is highly doubtful that a credible African agency can be set up with funding of less than $500 million, and even more implausible that investors would be keen. The question then is how much would each 1% of new market share cost in Africa? Quite a pretty penny is my guess.
Where then will the money to set up the African Credit Ratings Agency (AfCRA) come from?
Even if the startup capital is somehow found, some thought would still need to go into the long-term financial viability of AfCFRA.
There are a number of specific reasons why AfCFRA’s financial viability could be even more constrained than its European counterparts.
Issuance Rate
At the end of the day, the main income of a rating agency comes from the frequency of paid rating activity.
Branding and Marketing
Another hurdle to bear in mind is the challenge of growing brand recognition and then ensuring that reputational guardrails exist to prevent slippage.
Regulatory Hurdles
The idea of an African Union - sponsored ratings agency also raises questions about regulatory dynamics. Would such an entity be intergovernmental in character, and be governed by member states?
Transparency and Accountability: A New Approach
For African countries, this opacity can be especially damaging. When rating decisions lack transparency, it’s impossible to challenge potential biases or inconsistencies in methodology that put developing economies at a disadvantage. Africa’s new credit rating agency has the chance to change this.
The African Credit Rating Agency is an initiative under development by the African Union and its partners. It is more than a new entrant; it is an attempt to rethink how financial authority is earned, exercised and scrutinised.
Success for the African Credit Rating Agency shouldn’t be measured by whether it displaces the “big three” rating agencies (Standard & Poor’s, Moody’s and Fitch).
The three big agencies do publish their methodologies - their criteria and risk models. This creates an illusion of transparency.
Research has shown that credit rating agencies are more accurate at assessing the creditworthiness of advanced economies than developing economies. There have also been studies on the discrepancy between what is expected when the public methodologies are applied and what the agencies actually rate. This discrepancy exposes an accountability void.
The agency could use artificial intelligence to analyse patterns across committee discussions, flagging potential regional biases or inconsistent methodology application. It might be able to use secure digital ledgers to create unchangeable records of decisions.
Looking Ahead
Governments can begin by investing in stronger data systems and institutional capacity to ensure that credit ratings accurately reflect real risk and resilience, not outdated assumptions.
Credit rating agencies must also recognize the profound human consequences of their assessments and adopt more inclusive, context-sensitive approaches.
Agencies should also engage in transparent, two-way dialogue with African finance ministries, regional bodies, and development institutions to ensure their methodologies reflect local realities rather than global templates.
The development community, in turn, should treat credit ratings as a development emergency-mobilizing support and reform with the same urgency as a health or climate crisis.
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