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Is South Africa a junk bond nation?

Examining the power of credit rating agencies and South Africa’s latest grading.

It certainly has been a week of gloom. But even for my pessimistic bent, the hysteria all seems to have been a bit over the top with a touch of professional expediency and media sensationalism, in turn unleashing the clichéd yapping of political fox terriers.

The spook of “fiscal cliff” is just one example. Most countries, including many of blue chip ratings, plunged over that cliff some time ago. Their government debt to GDP ratios far exceed ours, at less than half of GDP, and the world average at above 100%. Apart from the Sudoku nature of these metrics, these countries have simply learned how to abseil down that cliff despite not knowing how much rope is left. That rope is the ability to play with the assumption that the bigger and more powerful you are, the longer the rope you have. There’s something quite immoral in that concept – one that applies equally to individuals in withholding credit from the needy, but supporting reckless ostentation of a few.

Adding to the dimming of the lights was Moody’s downgrading of South Africa’s credit rating, which triggered an unsanctionable hysteria of imminent junk-bond status. Not likely, according to this recent well considered argument with some highly informative charts by David Knee, head of fixed income at Prudential. To this I would add a few more, perhaps subjective and speculative, considerations.

  • Credit ratings are, by their very nature, comparative and with bourgeoning debt and continued lower economic growth in many countries, there should be a logical resistance to downgrades in isolation of the overall global environment.
  • As a country, sovereign debt nears speculative or non-investment grading and the implications of a downgrade become severe, arguably requiring a major economic shock or change in circumstances to warrant a plunge to junk bond status.
  • Could this, one wonders, open such an agency to a libel suit, as we have already seen in the $5bn claim against Standard and Poor’s?

The ratings agencies themselves have come under severe scrutiny since the collapse of 2008, shouldering much of the blame for those events and posing the question of who rates the raters and indeed even whether they have a right to exist. This is not a new debate and in defence the agencies can employ disclaimers, while their supporters argue that they are merely expressing an opinion under freedom of speech.

This is disingenuous. They are not merely a messenger. While it is true that their pronouncements are based on mostly known factors, arguably not always fully and independently researched, they can and do have a severe impact on the lives of millions. In some cases they have regulatory weight behind them with statutory rating requirements for institutional investors such as pension funds. In America, regulations still make it virtually impossible to sell unrated bonds.

It is a moot point whether these agencies are comfortable with this power. But they have it. Whether they deserve it or should have it has become academic but under such circumstances they can expect their credibility to be constantly challenged, sometimes unfairly, but also with some justification.

For one thing they are puppet masters in the murky world of financial services and create frenzied speculation that presents an enormous cloud over the real global economy. As such there is a high inherent danger of them being incubators of insider trading that could make the Libor scandal look like shoplifting a Crunchie chocolate from Checkers. In fairness again, so far there has not been a hint of that.

Perversely, scrutiny and potential lawsuits could affect their judgement, especially when it comes to sovereign risk ratings. It is far safer to be pessimistic than optimistic. Being in a speculative environment, this could have a subconscious negative effect on the ratings of less popular and riskier instruments, especially adjustments in response to changing conditions. This may be understating their objectivity, but that is simply the subjective nature of the beast.

Then there’s the tricky intermediary role between issuers and investors. Credit rating agencies’ income is sourced mainly from issuers. Entities that issue investment instruments hire ratings agencies and can fire them if they do not like the ratings, presenting an inherent conflict of interest between the transacting parties.

At the very least it is an industry still very much in a state of change and constant reform. There have been ground breaking amendments to America’s Dodd-Frank Act, enhancing SEC controls over agencies, while most countries including Europe have been revamping domestic legislation covering the industry. The point is whether one can expect such legislation to eventually guarantee the same impartiality, accountability and liability applicable to independent auditing firms.

The greatest indictment of the industry is its restricted nature. There are really only three global players all with a mostly Western Anglo Saxon perspective. They control 95% of the global market, with Fitch having 15%, Moody’s 40% and S&P 40%. It is a very profitable business, and despite the serious knock to their reputation in 2008, the three agencies are thriving with the explosion of paper in the bond and securities markets.

As far as South Africa is concerned, unless there is a new unforeseen and major shock (of which hopefully the latest organised labour turmoil will not be one) we do not deserve and are not near junk bond status. We may even be able to tap alternative funding such as from the BRICS development bank.

Of course, as we have seen with Eskom, ratings for other South African borrowers are a different matter. They will not only have to deal with additional pressure from a lower sovereign debt rating but face closer scrutiny of their individual prospects and management – perhaps not such a bad thing given the appalling state of many of our state owned enterprises.

Our collective institutions and their leaders representing government, business and labour need a much louder wake up call. If this has to come from a downgrading of our sovereign debt, then so-be it.

They may even deserve it, but for the most part the real victims, ordinary folks don’t!

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