South Africa’s global wealth eroded in the past four days

‘I would venture that the minister of finance can almost do whatever he likes; the problem is beyond him’ – Adrian Saville, chief strategist – Citadel.

TUMISANG NDLOVU: Time to get into the day’s top business news, staring with this evening’s breaking news – that S&P Global has downgraded South Africa following the latest cabinet reshuffle. Chief strategist at Citadel, Dr Adrian Saville, joins us on the line for this discussion. Good evening.

ADRIAN SAVILLE: Evening, Tumi.

TUMISANG NDLOVU: What a night! Just as we thought we had dealt with all the shocks from last week, a dramatic beginning to this week. What has been your reaction to the latest developments?

ADRIAN SAVILLE: Unsurprising. For a long time my view has been that South Africa would avoid a downgrade by virtue of our institutional strength. What was missing in action was economic growth and, if we got the economic growth story back on track, we would be in much better shape.

But that growth story was just starting to repair in the early parts of this year as the effects of drought abated, commodity prices improvements followed through and made themselves felt, currency volatility was working out of the system, inflation was calming, pieces of the jigsaw were starting to pull together – not into a robust story, but into at least a decent story. But the night of the long knives, I’m afraid, has put paid to that.

TUMISANG NDLOVU: Talk to us about what a downgrade actually means. S&P has downgraded South Africa to junk status. Just unpack that for us slowly for most of us who may not understand what exactly it means.

ADRIAN SAVILLE: First there is, I suppose, sensationalism in this, which is that South Africa’s been swept aside and in one fell swoop it’s all over. That’s not really the case at all. For a country to be kicked out of the world government bond index two things need to happen. The first is you need consensus among agencies – which means you need more than one agency to downgrade you. As things stand, only S&P has done that. Of course, this is in real time, so while we speak it could well be that one of the others has joined. But you need at least two to make the rating.

The second is that the rating needs to be on your domestic debt, not your international debt. And it’s South Africa’s dollar-denominated debt that has been put into sub-investment grade, and by one agency. So this unquestionably is a negative; it sends clear signals to capital markets and hopefully also to policymakers. But it doesn’t represent quite the drama that I think sensationalism points to.

TUMISANG NDLOVU: Which we definitely don’t need at this point in the country. Are other rating agencies expected to take their cue from S&P? We know that Moody’s has us just two notches above junk status, so maybe that decision might not be as aggressive. But do we expect the other rating agencies to follow suit?

ADRIAN SAVILLE: In a note that we sent to our clients on Friday, which I was responsible for putting together, I suggested that the most aggressive agency, S&P, was on the front foot and that it looked inevitable that we would be downgraded by them. And ja, I would agree with your sentiment. So this probably provides a fairly clear lead to the other agencies. To me the tragedy is that the impact of a downgrade is overwhelmingly lost – isn’t always appreciated and the effects are felt a long time after. They come in the form of higher costs of borrowing for homeowners, for vehicle owners, inflation that impacts consumers; and it’s the poorest that invariably are hit the hardest.

But these things generally only make themselves felt in three, six months’ time.

TUMISANG NDLOVU: Right. So it’s not going to be something that we are going to feel immediately.

ADRIAN SAVILLE: No, you’ll wake up tomorrow and you might be despondent, but your economic circumstance feels the same. It also shouldn’t be lost on us, though, that, if you were living on Mars, you would feel very sorry for South Africans because just ten days ago we were converting our wealth at R12.40/dollar, and this evening it’s almost R14/dollar. So that means from a global purchasing power perspective I would attribute this to the night of the long knives – that South Africa’s global wealth has been eroded in the past four days by those decisions.

TUMISANG NDLOVU: Speaking of the rand, we saw that it began on the back foot after that cabinet reshuffle and now we’ve got news of S&P Global downgrading South Africa, and it has continued to slide. Talk to us about that.

ADRIAN SAVILLE: Well, the rand’s strength has surprised me. I think it has surprised everyone just how resilient, robust the rand has been. I gave you the R12.40 number a few sentences back and to a large extent I think that’s been helped by a rand that was extremely oversold a year ago. So the recovery isn’t so much that the rand has strengthened. It was making its way back to fair value.

You’ve also had commodity prices helping, and this big risk-on event that has come to surround markets with the so-called “Trump Pump”. Those things I think have colluded or conspired to translate into rand strength, but it’s not just the rand that’s been strong. Certainly the real, the Indian rupee. The rand, though, has been among the strongest of world-traded currencies, and now that’s working its way out of the system as people revisit their assessment of the prospects for South Africa, which have distinctly worsened.

TUMISANG NDLOVU: Now, Adrian, can the country afford to be downgraded? What does it mean for South Africa in terms of the budget that we heard from our former finance minister, Pravin Gordhan?

ADRIAN SAVILLE: It raises the cost of borrowing, and cost of borrowing has become a growing item in our budget line items. And with higher interest rates that will come about because of the downgrade – and that’s on international as well as domestic debt – that cost of borrowing means more of our budget now will be allocated to paying interest expenses, and that interest expense is crowding out – to use the economic or text-book terminology desperately needed spending, such as the promotion of small and mid-sized enterprises, infrastructure spending and of course social welfare budget allocations. The obligation to service your debt gets in the way of all of those other much-needed expenditure items.

TUMISANG NDLOVU: We know that the former finance minister and a delegation from South Africa and the business sector as well as civil society were overseas to promote the country and continue their work in branding South Africa and presenting South Africa as an investment destination, and continue to convince rating agencies that all is well in South Africa. What can the newly appointed minister or the ministerial heads do to calm the situation now that S&P has gone ahead and downgraded South Africa?

ADRIAN SAVILLE: Wow. We probably need an evening to wrestle with that. The most important thing is policy consistency and transparency. Gigaba has made an effort to try and be very clear that policy doesn’t change, that they will be consistent in the application and so on. Unfortunately, going on behind this is a veil of secrecy that leads the top six to be divided, the secretary-general to say that he’s not sure where decisions are being taken, and the deputy head of state to take a very firm bold stance, to say that this is not the way decisions are made.

So I would venture that the minister of finance can almost do whatever he likes; the problem is beyond him.

TUMISANG NDLOVU: Interesting developments. Thank you so much for your input. Always a pleasure speaking to you, chief strategist at Citadel, Dr Adrian Saville on Money Talk with Moneyweb, talking to us about this evening’s breaking news of S&P Global downgrading South Africa following the recent cabinet reshuffle.

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