Junk status – what it means and what investors should know

A downgrade will have repercussions for all South Africans.

Junk status and downgrades are terms that have dominated economics news the past year as the local economy continues to deteriorate and the precarious state of state-owned enterprises is highlighted, almost daily.

The current status:

On November 1 Moody’s kept South Africa’s credit rating at their lowest grade rating but downgraded the outlook from stable to negative, which gives the country a period of 18 months to get its act together, so to speak.

Moody’s, unlike S&P and Fitch, relies heavily on quantitative scores, which have been marked down because of:

  1. Fiscal pressure and low growth which have led to a steep rise in government debt, currently over 60%.
  2. The agency raised ‘susceptibility to event’ score risk which effectively means they are more concerned regarding SA’s political obstacles that need to be reformed. For instance, political infighting that has generated policy uncertainty.

The minister of finance, Tito Mboweni’s mid-term budget announced in October did not help matters and showed how the governments financial situation is deteriorating rapidly.

South Africa moved deeper into junk territory as it lost the only stable outlook on its credit ratings when S&P announced late November it has changed its outlook on SA to negative.

At a recent local investment seminar, one speaker compared SA to other emerging countries and said the only positive aspect to note is that South Africa’s external debt as a percentage of GDP is nowhere near the level that would warrant an IMF bailout, at this time.

What can be done to prevent junk status?

  • Public sector wage cuts – it is alarming that the average civil servant earns R100 000 more per year than an employee in a similar position in the private sector, as highlighted in a recent report by Stats SA.
  • Tangible progress on Eskom – a new CEO appointed is perhaps a step in the right direction as Eskom remains the biggest threat to the economy.
  • Progress on addressing corruption – prosecution at a high level needs to happen.
  • Continued progress at Sars – the president and minister of public enterprises, Pravin Gordhan, have made some big changes, but this ship is not going to turn quickly after all the financial destruction that has occurred, and it will take time to fix.

What happens if SA is downgraded

Most analysts expect SA to lose its final investment grade rating but disagree when it will happen and what the consequences might be.

If Moody’s downgrades the country’s rating it means that South African rand bonds will be excluded from the FTSE World Government Bond Index.

The gloomiest commentators reckon a sell-off could be as bad as $10 billion worth of outflows, which will cause the rand to weaken to its lowest levels in four years. On the flip side, others say the downgrade is already priced in and SA assets may even rise in the aftermath, especially if sentiment towards emerging markets stays strong.

It could go either way at this stage.

What it means for individuals

A downgrade means that the government must pay more in debt servicing costs, meaning that it can spend less on social initiatives and infrastructure.

In order to plug the funding gap, the government will have to increase revenue through measures like higher taxes. As many top-earning (and thus tax contributors) South Africans are leaving SA it contributes to a fast-shrinking tax base which could have significant ramifications for individual taxpayers.

A downgrade also causes the local currency to depreciate, which makes imports like oil more expensive and this has a knock-on effect making a vast range of items more expensive. Individuals of all levels of income will feel it, particularly in lower-income groups.

When inflation rises above a targeted range it will push the repo rate up, which increases the cost credit for items like cars and, of course, mortgages.

Everyone in SA will be affected in some way.

How does it affect investment portfolios?

Investing in this current world is not as it used to be, old theories and investment cycles particularly are skewed in a volatile market and political environment. The one thing that investors need to be is adaptable to change, to prepare for difficult times and plan ahead.

Strongly consider investing any discretionary funds, not required for living expenses, offshore.

Don’t discount RA contributions for the tax benefits but always maintain healthy diversification in different investment options, regions and asset classes.

Investors who are drawing from pensions or retirement funds should keep drawings within inflation bands and ensure that their investment strategies include other economies and geographies. The SA equity market makes up a very small percentage of the world’s GDP.

That’s not to say SA equities should be avoided in entirety, but it is advisable to have a healthy allocation to cash and bond funds in an overall strategy.

It is always important to match asset allocation to risk profile. In this environment, an actively managed portfolio will deliver far superior returns compared to passive local and offshore portfolios. Passive works very well when markets rise, whilst active management allows for risk to be reduced when appropriate. A good combination is always advisable.

Lastly, investors need to come to grips with the fact that they are likely to live longer and therefore will probably need to work longer. Any retirement strategy now needs to provide for many longer-term scenarios.

Thinking about retirement at age 55 or 60 is an outdated concept and unrealistic for the savings required to support 25 to 30 years of living expenses when no longer earning an income.

To assess investment portfolios and review issues like risk tolerance, it is prudent to consult a qualified, accredited financial advisor. Details of our team and our offering here: Brenthurst Wealth

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