The Inevitable Downgrade for South Africa

South Africa finished 2019 on rough footing with the economy slipping into recession in the second half of the year. A weak economy, falling currency, and high debt levels all continue to plague the South African economy. With the country now on lockdown to contain the COVID-19 novel coronavirus, things are likely to get much worse, even as the country’s central bank actively works to mitigate the economic impact of the shutdown.

Downgraded to Junk

On March 27, 2020, Moody’s downgraded South Africa from an investment-grade rating to Ba1, maintaining a negative outlook. According to Moody’s, this downgrade to a “junk” rating was due to the country’s weak economy and unreliable power sector.

A week after the Moody's downgrade, Fitch Ratings downgraded South Africa’s Long Term Foreign-Currency Default Issuer Rating (IDR) from BB+ to BB with a negative outlook. The agency is forecasting a 3.8% contraction for the South African economy in 2020. According to Fitch, the downgrade is due to the lack of a clear path towards stabilizing South Africa’s debt position as well as the worsening effect that the COVID-19 pandemic is having on the economy.

The Rand at an All-Time Low

The rand, which has been on the ropes for a long time, has been under significant pressure in recent weeks. The currency recently hit fresh lows near 19 to the dollar; for the year, the currency is down 23% against the dollar. A weaker currency means that South Africa must import goods at higher prices. The impact of this is material, given that South Africa’s imports of goods and services represent nearly 30% of total GDP. This will have inflationary implications that make it difficult for the South African Reserve Bank (SARB) to continue to apply its accommodative monetary policy.

Pessimism in the Face of the Coronavirus Pandemic

The downgrade leaves South Africa without an investment-grade rating, which could cause it to fall out of the FTSE World Government Bond Index (WGBI) after April. One of the criteria for being included in the index  is an investment grading from one credit rating agency, and South Africa has now been junked by Moody’s and Fitch—S&P had already assigned South Africa a junk rating.

This could prompt significant capital outflows from South Africa over the course of 2020. It will also raise borrowing costs, complicating the government’s efforts to narrow the budget gap.

South Africa could also lose its status across other bond indices. Some of the large institutions with big but presumably now shrinking pockets will be prohibited from buying the country’s bonds. This would trigger billions of rand in capital outflows as global investors tracking the index are forced to sell. 

FTSE Russell, which administers the WGBI, has decided to postpone the monthly reweighting of its fixed-income indices until the end of April due to unnatural liquidity challenges and increased volatility due to COVID-19. Thus, the decision on South Africa’s inclusion in the index has been delayed.

The Central Bank Playing an Active Role to Ensure Cash Flow

Central banks around the globe have been active in reducing the economic impact of COVID-19 on the world economy. In a crisis, ensuring the free flow of credit is essential to prevent sudden lending freezes and a cascade of defaults that would paralyze economic activity. In an extraordinary move to cushion the impact of the COVID-19 pandemic, the SARB has instituted several measures to facilitate the flow of money in the economy as the country deals with the crisis.

The interventions include quantitative easing that has the central bank buying longer-term government securities to increase the money supply and encourage lending and investment. Furthermore, the Monetary Policy Committee within the SARB lowered the repurchase rate by a full percentage point in March 2020 to decrease the burden on consumers; this brought the bank’s policy rate to a six-year low of 5.25%.

The measures above have been introduced to help mitigate the economic costs of the COVID-19 shock by supporting the spending power of firms and households. The country has been on lockdown since March 27; the lockdown was originally due to last 21 days, but President Cyril Ramaphosa recently extended it by two weeks, to the end of April. The SARB predicted that the original 21-day lockdown could result in approximately 370,000 job losses and 1,600 businesses being declared insolvent in the country. The impact is now likely to be even more severe due to the extension.

COVID-19 Deals Another Blow to the South African Economy

South Africa slipped into a technical recession in Q4 2019, as GDP fell by 1.4% on the heels of a 0.8% contraction in Q3 2019. The economy expanded by just 0.2% in 2019, the slowest annual growth since the 2008–2009 global financial crisis. South Africa’s unemployment rate has been steadily increasing over the last four years, stabilizing at 29.1% in Q4 2019.

On top of the challenges posed by South Africa’s ongoing domestic economic problems, the global coronavirus pandemic has left the country in a considerably weaker position. The March economic forecast of the SARB projected a 0.2% contraction in real GDP in 2020; however, this projection predates the government’s decision to lock down the economy. In the bank’s April 2020 Monetary Policy Review, the bank estimates that, “2020 growth will be in a range of -2% to -4%, with downside risks should the lockdown be extended, or if the global economy weakens more than currently projected.” Analysts surveyed by FactSet are somewhat more optimistic, predicting a contraction of -1.6% for CY 2020 followed by an expansion of 1.2% for CY 2021.

Conclusion

South Africa continues to be beaten down by an unreliable electricity supply, a persistently weak business environment, and low levels of investment—all of which represent major downside risks to South African economic growth. Until the government can engineer a solution to multiple systemic problems, the country’s economic future remains uncertain.

Sara B. Potter, CFA also contributed to this article