by In June, Standard & Poor’s (S&P) will make its decision on whether to downgrade South Africa’s credit rating to junk status or not.
There has been a lot of hype surrounding this topic. After all, a downgrade by S&P will have major consequences for our economy. But what exactly is South Africa’s credit rating referring to? And why could it get downgraded? What are the consequences and most importantly, how can South Africans prepare for it?
What is South Africa’s ‘credit rating’?
Think of South Africa as an individual. When an individual requires money, they go to the bank in order to take out a loan/bond. When the South African government requires money, the government issues bonds for the public (foreigners and locals) to invest in.
So the public is playing the role of the bank and the government is the ‘individual’ receiving the loan. A pre-determined interest is applied to these bonds, and the government pays back the money, with interest, over a period of time. This process is common practice in many countries.
Now think of a young high-income professional approaching a bank for a loan. The bank consultant inserts information regarding the individual into a computer system and the computer system does its analysis. More than likely, this individual will get charged a low-interest rate from the bank simply because there is a lower chance that he will default and hence he is a safer investment for the bank.
However, if a low-income individual approaches the bank for a loan, we can almost guarantee that this individual will be charged a higher interest rate because there is a higher chance that he will default and hence is a riskier investment for the bank.
Currently, for argument sake, South Africa can be considered a ‘middle-income individual’. When people say that South Africa’s credit rating could be getting downgraded to junk status, it means that Standard & Poor’s Credit Rating Agency (“the computer system”), after doing its analysis, may conclude that South Africa can no longer be considered ‘middle-income’ and will downgrade the country to a ‘low-income individual’, i.e. junk status.
Therefore the government will be charged a higher interest rate on the bonds that they issue because of the higher risk associated with investing in the country.
Why could South Africa be getting downgraded?
There are several economic factors involved. I won’t go into detail but I will list a few:
- Politics and corruption in South Africa
- The USA is increasing interest rates and this negatively impacts our economy.
- China’s economy is slowing down and as a result they require less of our raw materials.
- Investor confidence in South Africa is poor due to electricity issues in the past, strikes in the mining sector and corruption in the government.
What are the consequences?
If South Africa’s credit rating gets downgraded, government will be charged higher interest on their bonds. This results in less funds available for the public. There is already a substantial deficit in South Africa’s current account so a downgrade may require an increase in taxes in order to combat this deficit.
A downgrade may also result in cash outflows from our financial markets. Many foreign investment companies invest their funds into South Africa. However, many of these investment companies are not allowed to invest into a country that has junk status and will be forced to withdraw their investments. This will result in a drop in the markets, i.e. your investments will take a knock.
The cash outflows will also result in the Rand weakening which in turn will result in an increase in inflation and a need for the South African Reserve Bank to increase interest rates.
As you can notice, a downgrade in South Africa’s credit rating will directly impact our finances. We have no control over the outcome of S&P’s decision, however, these are certain measures we can take in order to prepare for the worst:
1) Ensure you have an emergency fund in place. A unit trust is the best option because you have instant access to your money while at the same time you earn market-related returns.
2) Stay away from short-term debt such as personal loans and retail accounts.
3) Get in touch with a qualified financial adviser and use his advice on financial planning and money management.
4) If you are considering purchasing a vehicle or a property, take the monthly instalment and increase it by 20% to account for the potential increase in interest rates. Then consider whether you can afford the increased monthly instalment. If you can, great. If you cannot, reconsider the purchase.
5) Do NOT live above your means. When an economy is booming, you may get away with this. But 2016 will not be a booming year for South Africa and living above your means will catch up to you.
6) Be wise this year. Be pro-active about your finances. Look for ways to save money (e.g. reward programs) or ways to cut down on expenses (taking advantage of grocery specials). Essentially, you need to live away from the edge.
