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Junk! Where to now?

Junk status. This very vivid term makes for good headlines, but is unhelpfully alarming.

‘Junk’ does not indicate that a country is worthless as an investment destination, or that its economy is on the brink of collapse. Rather, the description indicates a rating below investment grade. The distinction is important. S&P’s decision to reduce South Africa’s foreign currency sovereign credit rating to junk status will have severe consequences for us all, but there is still hope that we can reform and rebuild.

In order to appreciate what junk status will mean for the economy, and what we might do about it, let’s briefly consider how we got here.

Political maneuvers

Commentators generally agree that Pravin Gordhan performed admirably as finance minister. That doesn’t make him irreplaceable. Malusi Gigaba, Gordhan’s successor, has considerable government experience, and could reasonably be expected to run the department ably, especially with the assistance of the expert staff at Treasury.

The downgrade is not about any single individual but about the apparent failure of our institutions to ensure accountability, transparency and stability.

S&P’s explanation for the adjusted rating included a clear statement of concern about policy uncertainty: “The 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. This has increased the likelihood that economic growth and fiscal outcomes could suffer.”

In other words, it is not the replacement of the finance minister per se, but the fractious political climate and its resulting uncertainty, that is cause for concern.

If there is a silver lining, it is that President Zuma’s cabinet reshuffle, and now the S&P downgrade, have galvanised South Africans to take a stand. Significantly, this is not a partisan issue. The EFF, DA and other opposition parties, as well as a number of senior ANC figures, have expressed deep concern about the current political situation and the consequences for ordinary South Africans.

The economic consequences

The economy is an interconnected system. ‘Junk status’ requires many overseas institutional investors will be required to disinvest from South African bonds, as they are mandated only to hold investment grade securities. (At the time of writing, verdicts from Moody’s and Fitch are still forthcoming.)

A general loss of investor confidence will see an increased reluctance by international investors to buy South Africans bonds and equities. Local investors looking to preserve their wealth will rush to take their money offshore. The consequence will be a loss of value of the rand.

A declining rand will increase the price of imported goods, including basic goods such as food and fuel.

The rise in living costs will be hard enough, especially for the poor. However, countermeasures will also be tough on the pocket. In order to curb inflation, the Reserve Bank would be expected to raise interest rates, increasing the cost of borrowing.

South Africans are already burdened with very high levels of debt, and a spike in interest rates will make it even harder to make ends meet.

Investors are also less likely to invest in South African businesses, which will affect economic growth and make it harder to reduce unemployment. Existing jobs will become more precarious.

The systemic effects of a general loss of investor confidence make the consequences of a downgrade so serious. A rise in the cost of living in a dynamic economy where jobs are abundant is one thing. Sluggish growth, a rise in the cost of living, more expensive household debt and job scarcity – as well as the possibility of a rollback of government services  – give households very little financial breathing room. The effects are compounded by losses on the JSE, which reduce the value of ordinary workers’ pensions.

A perfect economic storm. Loss of investor confidence produces synergistic effects which reinforce each other, making life more difficult for ordinary South Africans.

The severity of the downturn is yet to be determined. It would be naive to think that we can avoid any fallout from the present political upheaval, but it is not too late to contain the the worst effects.

Restoring investor confidence is a gradual process that will take concerted effort and a vocal defence of our institutions by South Africans of all backgrounds. We may have different visions of how the economy ought to be run, but most citizens agree that a transparent and accountable executive is a necessary feature of a stable and prosperous society.

Picture: Finance Minister Malusi Gigaba.  Image by GovernmentZA under CC2.0