South Africa: Can SA Take Another Blow After Moody's Downgrade?

opinion

LAST week, global top tier credit rating agencies Moody's and Fitch downgraded South Africa further into junk status territory, while S&P Global maintained a BB/B rating on the country.

Fitch downgraded the country to BB- and Moody's notched it down to Ba2. This was followed by warnings that the country could face further downgrades in the medium term.

Tafara Mtutu

Investment analyst

Both agencies hinged their downgrades on the country's rising debt burden; high unemployment rates; a poor economic growth trend, and the impact of Covid-19 on the economy.

According to Stats SA, South Africa's debt has ballooned to R4 trillion (US$262,5 billion) and it recorded an annualised GDP contraction of 51% in the second quarter of 2020. The resulting debt burden, proxied by the Debt-to-GDP ratio, of 63,3% therefore comes as no shock. This is a notably above the BRICS average of c.52%. Further, South Africa's debt-to-GDP ratio is expected to further deteriorate in the coming years. South Africa's Minister of Finance Tito Mboweni reacted to the downgrade by calling it ". . . a painful one," and highlighted that economic reforms are urgently needed in the country.

The downgrades hold adverse implications that include, but not limited to, higher cost of debt, a weaker currency, a decline in economic growth, and lower disposable incomes. While there are benefits to a weaker currency, such as improved export figures and a smaller current account deficit, these simply do not outweigh the many negatives that have been building up in South Africa for the better part of the last decade.

This also comes at a time when South Africa's high net worth individuals (HNWIs) are flocking out of the country in droves because of perennial socio-economic and political issues. HNWIs are individuals with a net worth in excess of US$1 million. The migration of HNWIs can be considered as a leading indicator of economic performance considering that HNWI migration usually precedes poor economic performance.

According to statistics from AfrAsia Bank, more than 4 000 of South Africa's HNWIs have left the country in the last 10 years. Although pandemic-driven travel restrictions throughout the globe limited HNWIs' migration out of the country in 2020, the trend remains strong with detrimental effects on South Africa. HNWIs are finding safe haven in countries such as Portugal, Australia, Canada, Switzerland, the United States, and the United Kingdom. This might seem inconsequential at first glance, but couple that with South Africa's unmatched inequality and this paints a bleak picture on South Africa.

South Africa's level of inequality is the highest in the world, with a Gini coefficient of 0,63. The top 10% of South African earners take home 65% of all income in the country, while the remaining 90% take home the remaining 35% of total income. In addition, a study by Stellenbosch University economist Anna Orthofer showed that the wealthiest 1% in South Africa own 67% of all the country's wealth and the top 10% own 93% of the country's wealth. The remaining 7% is shared between the remaining 90% of South Africans.

If we use the inequality statistics as a preamble to our story, then the migration of top earners from South Africa could also mean a migration of most, if not all, of the country's wealth. As if this is not enough, there is evidence that shows an inverse relationship between downgrades and FDI flows in South Africa (Mugobo & Mutize, 2016), which suggests that foreign capital coming into South Africa may not match capital moving out, especially in light of corruption allegations and land expropriation without compensation considerations in recent years.

All these expectations are likely to maintain downside pressures on the rand relative to other currencies such as the greenback, despite an appreciation in recent weeks following the conclusion of the United States elections.

However, it is not all doom and gloom for South Africa. The southern African country remains the most industrialised nation on the continent. It has consistently recorded high private equity transaction activity in Africa, and it boasts of a banking system that is consistently rated as one of the most sophisticated in the world, among other positives.

Further, the pandemic that has taken the world by storm is likely to be less of a structural issue and more of one-time issue that will be addressed by a cocktail of Covid-19 vaccines and swift policies.

The downgrades may have not happened to Zimbabwe, whose credit ratings are already deep in junk status, but it will likely experience some temporary changes. Zimbabwe is chronically dependent on imports and South Africa is the country's largest trade partner. The downgrade's immediate impact of the rand could work to the benefit of Zimbabwe because of its US dollar-driven economy.

Imports from South Africa will be cheaper, and Zimbabwean importers will enjoy a brief period of the stronger dollar. However, as the downgrades' impact ripples and prompts higher costs of production through higher finance costs in the medium to long-term, the Rand prices of imported goods will likely increase and offset the depreciation of the currency.

Equity exposure to investors on the Zimbabwe Stock Exchange and Victoria Falls Stock Exchange is mostly limited to SeedCo International through its Prime SeedCo joint venture with HM Clause, Delta Corporation's latest acquisition of United National Breweries in South Africa, and Meikles' Cape Grace hotel in Cape Town.

The impact will be minimal for investors in SeedCo International and Delta Corporation given the defensive nature of their operations in South Africa. Prime SeedCo breeds vegetable seeds and United National Breweries manufactures opaque beer, a typical addictive and habit-forming product.

Food and beverages, especially alcoholic beverages, tend to weather temporary economic shocks better than other goods. Meikles, on the other hand, closely now exhibits characteristics of a consumer goods retailer with its Pick n Pay business more than a tourism and hospitality stock since the disposal of the iconic Meikles Hotel last year.

The hospitality segment now contributes less than 2,2% of total revenues, hence, any impact to the pandemic-stricken leisure asset will be immaterial with respect to the rest of the business.

Mtutu is an investment analysts at Morgan & Co

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