Junk Status Is Not The End – It Can Get A Lot Worse!

It is now widely expected that sometime in the next year or so Moody’s will downgrade South Africa’s debt to junk status. Many see this as the beginning of the process to rehabilitate ourselves. True, initially we will go through a difficult period as ±R150 billion of our debt will be sold as many offshore institutional investors cannot hold junk bonds which leads to a fall in the currency, higher interest rates and lower economic growth. But then we knuckle down and begin to reform the economy and embark on the process of returning to investment grade.

However – things can get much worse

Source : Moody’s 

We are currently Baa3 with Moody’s and are on a negative watch with them which means they will put South Africa on Ba1 (i.e. junk status) if we don’t get economic growth on an upward path and rein in our rising debt.

As you can see, we can keep dropping to Ba2 and all the way down to C which means South Africa has defaulted on its debt obligations and there’s little prospect of recovery.

It can happen – just look at Venezuela and Zimbabwe – where optimistic assumptions are made on economic growth and government expenditure but in fact the country just raises taxes, incurs more debt, until you need to borrow money just to pay off debt that falls due. Each drop on the Rating Matrix raises the cost of borrowing and the downward spiral continues.

The ultimate problem with this scenario is that it eventually becomes irreversible, which is when default on debt becomes a distinct possibility.

The reality is that until genuine reforms are put in place, we will continue to descend along the Rating Matrix ladder.

What should we be doing? 

Paying off as much debt as possible is a good start. We should also carefully consider any future expenditure and analyse just how necessary it will be, particularly if it is in foreign currency. Some analysts recommend that we should become as self-sufficient as possible (e.g. boreholes, solar power).