Finance Minister Pravin Gordhan is set to face corruption charges in November. Experts agree that the charges won’t hold up in court, but they could be used an excuse to recall Gordhan from his job. Given the dramatic way that markets and the rand reacted when former finance minister Nhlanhla Nene was replaced by David van Rooyen, the South African public could be in for a financial shock. Why exactly is a falling rand and the threat of a ratings downgrade so bad?
Investor confidence is the secret sauce for economic growth and job creation. Political instability and government mismanagement produce a loss of investor confidence. Consequently, foreign investors don’t want to invest in South African assets (government bonds and JSE-listed shares) and local investors want to take their money offshore. As a result, the rand loses value.
Low investor confidence also has direct consequences for business and employment. Less money invested in factories and businesses means fewer jobs, less chance of employees getting bonuses or raises and the chance that workers will lose their jobs. Unemployment and lower salaries also translate into less demand for goods and services, which can really hurt small businesses.
As the rand loses value, the cost of imported good goes up in rand terms. Technology and overseas holidays become more expensive, but so do basic goods like clothing and, notably, petrol. The severe drought also means that we may need to import food, which would be made similarly more expensive by a weak rand.
A weak rand doesn’t just make buying new goods more costly. As the rand declines, your South African assets (your home, your share portfolio, your cash investments etc.) lose value in hard currency terms. (To put that in global context, the rand amount you would now get for selling your Fourways home would buy you a much smaller home in Sydney or Toronto than would the same number of rands just a few months ago.) This loss of value can be compounded by a decline in the rand value of shares on the JSE.
It’s important to note that losses on the JSE don’t just affect rich investors. Million of ordinary workers have pensions with exposure to South African equities. Losses on the JSE equate to a loss of pension fund value and the potential future payouts workers can expect.
International ratings agency S&P is due to assess South Africa’s rating in December. It’s widely believed that if Gordhan is removed from his job, South Africa will be downgraded to ‘junk’ status, i.e. below investment grade. This would both reflect and reinforce the loss of global investor confidence in South Africa. Moreover, many international pension funds have strict rules about risk and would be required to disinvest from South African bonds, further hurting the rand and other economic indicators.
To counter the risk of inflation caused by the higher cost of goods resulting from the devaluation of the rand, the Reserve Bank will likely raise interest rates. This will increase the cost of borrowing, making it more expensive to repay mortgages and car repayments, amongst other debt. That’s bad news for a country with very high household debt levels like South Africa.
The upshot: a perfect economic storm. South Africans can expect lower wage increases, jobs could be lost, and those seeking work will have a harder time finding employment. Small business owners could also struggle. At the same time, monthly debt repayments will increase and the cost of basic goods, like food and petrol, will become notably more expensive.
Far from being a problem exclusively for elites, inflation, higher interest rates, a declining rand, rising unemployment and a fall in the JSE will hurt the poor and middle classes most severely.