tag:theconversation.com,2011:/au/topics/credit-rating-4754/articlesCredit rating – The Conversation2023-08-18T11:12:18Ztag:theconversation.com,2011:article/2110092023-08-18T11:12:18Z2023-08-18T11:12:18ZClimate change is making debt more expensive – new study<figure><img src="https://images.theconversation.com/files/543226/original/file-20230817-14573-wkk79g.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C5004%2C3333&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/tokyo-japan-august-26-2021-sign-2178575211">Ned Snowman/Shutterstock</a></span></figcaption></figure><p>Earth is overheating due to the greenhouse gas emissions from burning fossil fuels. This is “the biggest market failure the world has seen” according to economist <a href="https://www.aeaweb.org/articles?id=10.1257/aer.98.2.1">Nicholas Stern</a>. The rational behaviour of companies that pollute by making profitable commodities, and consequences of most people’s desire to drive everywhere are creating irrational outcomes for everyone: an increase in the average global temperature which threatens to make the planet uninhabitable. </p>
<p>But our <a href="https://pubsonline.informs.org/doi/10.1287/mnsc.2023.4869">recent research</a> indicates that this pollution will have a direct financial cost. We used artificial intelligence to combine Standard and Poor’s (S&P) <a href="https://www.spglobal.com/ratings/en/about/intro-to-credit-ratings">credit ratings formula</a> (which captures the ability of those who borrow money to pay it back) with climate-economic models to simulate the effects of climate change on sovereign ratings for 109 countries over the next ten, 30 and 50 years, and by the end of the century.</p>
<p>We found that by 2030, 59 countries will see a deterioration in their ability to pay back their debts and an increased cost of borrowing as a result of climate change. Our predictions to 2100 entail the number of countries rising to 81.</p>
<p>Financial markets and businesses need credible information on how climate change translates into material risks to be able to factor them into all decisions they make. Although it is important to design economic tools and policies that can mitigate the effects of climate change, the field of economics responsible for doing so is relatively young. </p>
<p>New financial products have emerged to help countries and investors take better account of the climate and environment being degraded as a result of debt markets, but several problems remain.</p>
<p>Credit ratings or environmental, social and governance (ESG) ratings (which assess how well a company manages these kinds of risks) are not based on scientific information, and are often charged with <a href="https://www.ft.com/content/74888921-368d-42e1-91cd-c3c8ce64a05e">greenwashing</a>. For example, some investment funds branded as green according to these ratings, have been <a href="https://www.theguardian.com/business/2023/may/02/green-investment-funds-pushing-money-into-fossil-fuel-firms-research-finds">linked to fossil fuel companies</a>.</p>
<p>Financial institutions such as banks frequently misunderstand models for predicting the economic costs of climate change and underestimate risks such as <a href="https://www.ft.com/content/a5027391-41a4-4e21-a72d-f8189d6a7b71">temperature rises</a>, according to a <a href="https://actuaries.org.uk/media/qeydewmk/the-emperor-s-new-climate-scenarios.pdf">recent report</a> by actuaries – people who use mathematics to measure and manage risk and uncertainty.</p>
<p>Their research found “a clear disconnect” between climate scientists, economists, the people building these economic models and the financial institutions using them. </p>
<p>In our study, we tried to integrate climate science into financial indicators widely used and understood by investors, such as credit ratings. Without such science-based indicators, financial decision making will reflect risk calculations which are incorrect and misrepresent the <a href="https://www.nature.com/articles/s41558-020-00984-6">economic consequences</a> of climate change.</p>
<h2>Debt servicing to rise almost everywhere</h2>
<p>Credit ratings express a country’s ability and willingness to pay back debt and affect the cost of borrowing to nations as well as other entities, such as corporations and banks. Inevitably, these costs are passed on to the public.</p>
<p>When interest rates rise for banks, businesses find it more expensive to fund their operations and so raise prices for consumers. Higher costs to banks also mean higher mortgage interest rates for residential borrowers. When banks invest savings such as pensions in bonds offered by countries hit by climate disasters, their worth is affected too, meaning that pensions may fall in value.</p>
<p>Our <a href="https://pubsonline.informs.org/doi/10.1287/mnsc.2023.4869">paper</a> has three key findings. First, in contrast to much of the economics literature, we found that climate change could have material effects on economies and credit ratings as early as 2030. </p>
<p>Credit ratings are categorised in a 20-notch ladder scale, with default being the lowest rating, equivalent to one notch, and AAA being the highest rating at 20 notches. The highest rating signifies the lowest risk of an entity not paying back its debts and vice versa.</p>
<p>Under a high-emissions scenario in which recent emissions continue on an upwards trajectory, 59 countries would suffer downgrades of just under a notch by 2030, rising to 81 countries facing an average downgrade of two notches by 2100.</p>
<p>The nations which would be most affected include Canada, Chile, China, India, Malaysia, Mexico, Slovakia and the US. More importantly, our results show that virtually all countries, whether rich or poor, hot or cold, will suffer downgrades if the current trajectory of carbon emissions is maintained.</p>
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<a href="https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="A global map depicting how much each country's credit rating is expected to fall." src="https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=363&fit=crop&dpr=1 600w, https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=363&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=363&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=456&fit=crop&dpr=1 754w, https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=456&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/543218/original/file-20230817-23-spmgd3.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=456&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Rating downgrades under a high-emissions scenario (20-notch scale).</span>
<span class="attribution"><span class="license">Author provided</span></span>
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<p>Second, if countries honoured the <a href="https://unfccc.int/sites/default/files/english_paris_agreement.pdf">Paris Agreement</a> and limited warming to below 2°C, the impact on ratings would be minimal.</p>
<p>Third, we calculated the additional costs of servicing debt for countries (best interpreted as increases in annual interest payments) to be between US$45–67 billion (£35-53 billion) under a low-emissions scenario, and US$135–203 billion under a high-emissions one. These translate to additional annual costs of servicing corporate debt, ranging from US$9.9–17.3 billion to US$35–61 billion in each case.</p>
<p>As climate change batters national economies, debt will become harder and more expensive to service. By connecting climate science with indicators that are already baked into the financial system, we’ve shown that climate risk can be assessed without compromising the integrity of scientific assessments, the economic validity of the modelling and the timeliness necessary for making effective policies.</p>
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<img alt="Imagine weekly climate newsletter" src="https://images.theconversation.com/files/434988/original/file-20211201-21-13avx6y.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/434988/original/file-20211201-21-13avx6y.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/434988/original/file-20211201-21-13avx6y.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/434988/original/file-20211201-21-13avx6y.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/434988/original/file-20211201-21-13avx6y.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/434988/original/file-20211201-21-13avx6y.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/434988/original/file-20211201-21-13avx6y.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p><strong><em>Don’t have time to read about climate change as much as you’d like?</em></strong>
<br><em><a href="https://theconversation.com/uk/newsletters/imagine-57?utm_source=TCUK&utm_medium=linkback&utm_campaign=Imagine&utm_content=DontHaveTimeTop">Get a weekly roundup in your inbox instead.</a> Every Wednesday, The Conversation’s environment editor writes Imagine, a short email that goes a little deeper into just one climate issue. <a href="https://theconversation.com/uk/newsletters/imagine-57?utm_source=TCUK&utm_medium=linkback&utm_campaign=Imagine&utm_content=DontHaveTimeBottom">Join the 20,000+ readers who’ve subscribed so far.</a></em></p>
<hr><img src="https://counter.theconversation.com/content/211009/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Patrycja Klusak receives funding from the International Network for Sustainable Financial Policy Insights, Research and Exchange (INSPIRE).</span></em></p><p class="fine-print"><em><span>Matt Burke receives funding from the International Network for Sustainable Financial Policy Insights, Research and Exchange (INSPIRE).</span></em></p>The first ‘climate-smart’ sovereign credit rating shows 59 nations will have lower ratings before 2030 without emissions cuts.Patrycja Klusak, Affiliated Researcher, Bennett Institute of Public Policy, University of Cambridge and Associate Professor in Banking and Finance, University of East AngliaMatt Burke, WTW Research Fellow, University of OxfordLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2085752023-07-04T02:11:08Z2023-07-04T02:11:08ZBanks put family violence perpetrators on notice. Stop using accounts to commit abuse or risk being ‘debanked’<figure><img src="https://images.theconversation.com/files/535239/original/file-20230703-194046-95aav6.jpg?ixlib=rb-1.1.0&rect=389%2C117%2C5540%2C3666&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Perpetrators of family violence will often use money to hurt and control their victims.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/search/financial-abuse?image_type=photo">Shutterstock</a></span></figcaption></figure><p>Ella never knew when her credit card was going to be declined.</p>
<p>It happened when she was shopping for groceries with her kids, or refuelling the car. That’s when she would discover her partner had cancelled the card or lowered the limit so she couldn’t buy essentials. Again. </p>
<p>Ella* (not her real name) is one of <a href="https://www.abs.gov.au/statistics/people/crime-and-justice/personal-safety-australia/latest-release#cohabiting-partner-violence-emotional-abuse-and-economic-abuse">about 1.6 million Australian women and 745,000 men</a> who have experienced economic or financial abuse. </p>
<p>Perpetrators of such abuse use money to control their victims, with devastating impact including stopping or limiting access to money, creating insurmountable debt and damaging a credit history.</p>
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Read more:
<a href="https://theconversation.com/higher-unemployment-and-less-income-how-domestic-violence-costs-women-financially-204688">Higher unemployment and less income: how domestic violence costs women financially</a>
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<p>The <a href="https://www.commbank.com.au/content/dam/caas/newsroom/docs/Cost%20of%20financial%20abuse%20in%20Australia.pdf">direct costs</a> to victim-survivors of financial abuse have been estimated at A$5.7 billion a year, with impact on the economy estimated at A$5.2 billion a year.</p>
<h2>The highly disruptive tactics used by abusers</h2>
<p>Perpetrators use a range of <a href="https://www.commbank.com.au/content/dam/commbank-assets/support/2020-11/unsw-report-1-financial-abuse-ipv.pdf">tactics</a>, some of which are inadvertently enabled by bank products and services. For example:</p>
<p>• credit cards are opened in the name of victim-survivors without their knowledge, potentially damaging credit scores </p>
<p>• all cash is withdrawn from joint accounts or redraw facilities without the consent of the other account holder</p>
<p>• legally binding property settlement orders to refinance home loans are ignored, forcing one party to seek help with repayments while trying to disentangle from their ex-partner</p>
<p>• payment descriptions are used to send threatening, abusive messages.</p>
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<a href="https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&rect=0%2C144%2C5691%2C3719&q=45&auto=format&w=1000&fit=clip"><img alt="Woman looks at the ATM in despair as she realises her bank account is empty." src="https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&rect=0%2C144%2C5691%2C3719&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/535233/original/file-20230703-252566-aa70gw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Money may be emptied from joint accounts or access may be blocked.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/search/financial-abuse?image_type=photo">Shutterstock</a></span>
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<p>Banks typically respond to these issues case-by-case, tailoring solutions for each customer. However, it may be possible to eliminate or reduce the need for these interventions with improved product design to prevent and disrupt abusers.</p>
<h2>Taking action against perpetrators</h2>
<p>My first <a href="https://cwes.org.au/wp-content/uploads/2022/11/CWES_DesigntoDisrupt_1_Banking.pdf">Designed to Disrupt</a> discussion paper for the <a href="https://cwes.org.au/">Centre for Women’s Economic Safety</a> proposes a new “financial safety by design” framework that tailors the <a href="https://www.esafety.gov.au/industry/safety-by-design">eSafety Commissioner’s work with the technology sector</a> and provides greater protection for victim-survivors.</p>
<p>It outlines steps banks can take to prevent their products being used as a weapon in domestic and family violence.</p>
<p>Recommended measures include setting up every joint account with separate passwords, logins, and portals for each person so it’s simpler and safer to separate if the relationship ends or is abusive.</p>
<p>Two of Australia’s big four banks, the National Australia Bank and the Commonwealth Bank have already agreed to adopt the primary recommendation – to include financial abuse in product terms and conditions as a reason for suspension or closure of accounts.</p>
<p>It’s likely other banks will follow suit, with <a href="https://www.westpac.com.au/about-westpac/media/media-releases/2022/22-november/">Westpac</a> signalling last November it would consider ensuring its terms and conditions reflect its no tolerance approach to financial abuse.</p>
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Read more:
<a href="https://theconversation.com/women-who-suffer-domestic-violence-fare-much-worse-financially-after-separating-from-their-partner-new-data-190047">Women who suffer domestic violence fare much worse financially after separating from their partner: new data</a>
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<p><a href="https://media-cdn.ourwatch.org.au/wp-content/uploads/sites/2/2021/11/18101814/Change-the-story-Our-Watch-AA.pdf">Evidence</a> shows that challenging the acceptance of violence against women is essential to respond to specific gendered drivers of violence.</p>
<p>In banking, this means spelling out the bank’s rules and its expectations of customer behaviour in its terms and conditions. These rules are the foundation of the contractual relationship with the customer and are relied on where there is a dispute.</p>
<h2>Banks taking the lead</h2>
<p><a href="https://news.nab.com.au/news/nab-takes-on-financial-abuse/">National Australia Bank</a> and Commonwealth Bank will change their terms and conditions to make it clear that financial abuse is unacceptable – just like financial crime or threatening call centre staff.</p>
<p>They will be the first Australian banks to signal to millions of bank customers they have a choice: abuse other customers and potentially lose access to their bank account, or behave with respect.</p>
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<a href="https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Woman sitting on floor with bills scattered around her" src="https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/535237/original/file-20230703-267810-azdorj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Persistent abusers may be denied banking services.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/search/financial-abuse?image_type=photo">Shutterstock</a></span>
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<p>This will make it harder for people to misuse financial products as a means of coercive control. </p>
<p>Implementation will be complex and the banks will need to proceed with caution. Financial abuse is hard to detect and there may be risks to the abused partner if perpetrators blame them for the bank’s action.</p>
<h2>Consequences for abusers who fail to stop</h2>
<p>An abuser may continue their behaviour at another bank. In this instance, there is the option of “de-banking” the customer which is not only a major inconvenience but also denies them access to an essential service.</p>
<p>That’s why it’s important the whole industry moves on this. It is instructive to examine the collective approach the banks have already taken to disrupt technology-facilitated abuse through payment descriptions.</p>
<p>Notably, my research found two banks reported more than 90% of customers discontinued abuse following a warning letter. </p>
<p>Implementation of the new terms and conditions should be guided by the experience of victim-survivors. It could also be informed by the Council of Financial Regulators’ <a href="https://www.cfr.gov.au/publications/policy-statements-and-other-reports/2022/potential-policy-responses-to-de-banking-in-australia/pdf/potential-policy-responses-to-de-banking-in-australia.pdf">de-banking policy recommendations</a> on transparency and fairness measures.</p>
<p>These measures include providing documented reasons to the customer with 30 days’ notice before closing services and giving them access to internal dispute resolution.</p>
<h2>Getting the public on board</h2>
<p>There also needs to be a public conversation about what this means. Airlines make it clear jokes about terrorism are not okay, and patrons are ejected from sporting events for violence.</p>
<p>If every bank in Australia makes it clear there is a minimum expectation of respectful behaviour to be a customer, it would be a game changer. </p>
<p>The widespread adoption of financial abuse terms and conditions and broad public communication will send a strong message to everyone with a bank account that financial abuse is unacceptable and has consequences.</p><img src="https://counter.theconversation.com/content/208575/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Catherine Fitzpatrick consults to Westpac and owns shares in Westpac and Commonwealth Bank of Australia. She received funding from the Centre for Women's Economic Safety to write the Designed to Disrupt report and continues to be affiliated. She is a former bank executive and established and led specialist customer vulnerability teams at CBA and Westpac. </span></em></p>Two of Australia’s major banks have announced they will take action against financial abusers, including closing their accounts.Catherine Fitzpatrick, Adjunct Associate Professor, School of Social Sciences, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1652982021-08-11T12:29:32Z2021-08-11T12:29:32ZCredit ratings are punishing poorer countries for investing more in health care during the pandemic<figure><img src="https://images.theconversation.com/files/415530/original/file-20210810-19-178x8bn.jpg?ixlib=rb-1.1.0&rect=175%2C146%2C4607%2C3105&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Morocco wanted to spend more on health care. As a result, its credit rating was cut. </span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/VirusOutbreakMoroccoVaccination/14a66c3698cb4f118b52942707c17d6a/photo?Query=Morocco%20covid-19&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=210&currentItemNo=53">AP Photo/Abdeljalil Bounhar</a></span></figcaption></figure><p>Economic recovery from the COVID-19 pandemic <a href="https://www.un.org/development/desa/dspd/2020/07/recovering-from-covid19/">depends on sustained investment</a> in health care and social services. But while rich countries like the U.S. <a href="https://www.imf.org/en/Topics/imf-and-covid19/Fiscal-Policies-Database-in-Response-to-COVID-19">can borrow and spend relatively easily</a>, low-income nations face a major obstacle: their credit ratings. </p>
<p>A credit rating, like a credit score, <a href="https://theconversation.com/why-credit-ratings-matter-and-why-they-cant-be-ignored-69361">is an assessment of the ability of a borrower</a> – whether it’s a company or a government – to repay its debts. Lower credit ratings drive up the cost of borrowing.</p>
<p>This threat prompted <a href="https://group30.org/publications/detail/4799">some poorer countries to avoid tapping investors</a> for vital financing during the pandemic, while other governments that made plans to spend more on public services <a href="https://www.reuters.com/article/us-ratings-sovereign-idUKKBN2B92OY">were hit with credit ratings downgrades</a> from private companies. </p>
<p>My <a href="https://sase.confex.com/sase/2021/meetingapp.cgi/Paper/17513">forthcoming research</a> shows that when credit ratings fall, countries tend to spend less on health care. This should be a cause for concern as the delta variant of the coronavirus <a href="https://coronavirus.jhu.edu/map.html">drives up case counts across the world</a>. </p>
<h2>Punished for health care spending</h2>
<p>A wide gap has emerged between rich and poor countries in terms of how much they are spending to fight the coronavirus’s impact and shore up their health care infrastructure. </p>
<p>Governments in rich countries <a href="https://www.brookings.edu/opinions/how-to-balance-debt-and-development/">have provided trillions of dollars</a> in direct and indirect support for their economies, on average about 24% of their gross domestic product. Developing economies, on the other hand, have been able to spend only a tiny fraction of that, an average of about 2% of their GDP. </p>
<p>Recent research found that a country’s credit rating <a href="https://www.nber.org/papers/w27461">was the largest factor</a> in how much a government spent on COVID-19 relief. That is, the lower a country’s rating, the less it was able to spend on health care and other social services. </p>
<p>For instance, Ivory Coast and Benin are the only two countries in sub-Saharan Africa that <a href="https://www.brookings.edu/opinions/how-to-balance-debt-and-development/">have been able to borrow in international markets</a> since the pandemic began. Others chose not to borrow, at least in part, it seems, <a href="https://group30.org/images/uploads/publications/G30_Sovereign_Debt_and_Financing_for_Recovery_after_the_COVID-19_Shock-_Preliminary_Report_1.pdf">out of fear of the ratings downgrades</a> that might result. This has prevented them from financing much-needed spending. </p>
<p>The fear is justified. Countries that planned to increase spending, such as Morocco and Ethiopia, were punished for it. Morocco’s credit rating, for example, was downgraded to speculative grade, or “junk,” by <a href="https://www.reuters.com/article/morocco-rating-fitch-idUSL8N2HE5YL">Fitch</a> and <a href="https://www.bloomberg.com/news/articles/2021-04-02/morocco-cut-to-junk-by-s-p-kn0qnt09">Standard & Poor’s</a> because of its plan to spend more on social services. <a href="https://www.worldbank.org/en/news/feature/2016/08/17/analysis-how-do-credit-downgrades-affect-short-term-government-borrowing">The ratings cuts will make it much harder</a>, and more expensive, for it to borrow from international investors.</p>
<p>And Moody’s Investors Service <a href="https://www.reuters.com/article/ethiopia-bonds/update-1-moodys-downgrade-over-g20-common-framework-hits-ethiopian-bonds-idUSL5N2N52KD">slashed Ethiopia’s credit rating</a> after the country sought debt relief from a <a href="https://www.imf.org/en/About/FAQ/sovereign-debt#Section%205">new Group of 20 program</a> so that it <a href="https://www.bloomberg.com/news/articles/2021-07-07/ethiopia-in-negotiations-to-restructure-1-billion-more-of-debt-kqte6iuj?sref=Hjm5biAW">could spend more on supporting</a> its economy and citizens.</p>
<p>Overall, despite spending far less during the pandemic, poorer countries <a href="https://www.reuters.com/article/us-ratings-sovereign-idUKKBN2B92OY">were much more likely than wealthier ones to see their credit ratings cut</a> by Fitch, Standard & Poor’s and Moody’s – the three biggest private credit rating agencies. </p>
<p>Low-income countries are therefore forced to choose between keeping their credit ratings stable and undertaking critical social services spending. </p>
<p>In my own research, which is currently under peer review, I looked at ratings changes across a group of 140 countries from 2000 to 2018. I found that downgrades in credit ratings lowered public spending on health care. </p>
<h2>The IMF’s rating system</h2>
<p>Even the International Monetary Fund, which is the main global agency that oversees development finance, uses a rating system that tends to penalize governments for any increase in public spending. That includes spending invested in their health care systems. </p>
<p>The IMF evaluates the creditworthiness of countries through a system it calls its <a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/39/Debt-Sustainability-Framework-for-Low-Income-Countries">debt sustainability framework</a>. Countries are classified into three levels of “<a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/39/Debt-Sustainability-Framework-for-Low-Income-Countries">credit capacity</a>” - strong, medium or weak. </p>
<p>Weak countries are deemed to have a low ability to handle additional debt based on their current levels of indebtedness. No distinction is made <a href="https://www.brettonwoodsproject.org/2017/12/debt-sustainability-review-tinkering-around-edges-crises-loom/">between debt</a> that was a result of important long-term investments in social services like health and education and debt incurred by more wasteful spending. Countries are then required by the IMF to improve their ratings as a condition of aid, such as by putting the focus on debt repayment, short-term economic objectives and across-the-board spending cuts. </p>
<p>An op-ed in The Lancet <a href="https://doi.org/10.1016/S2214-109X(14)70377-8">blamed similar IMF-induced austerity</a> in the early 2000s for a reduction in health care spending in Guinea, Liberia and Sierra Leone, leaving them susceptible to the Ebola crisis in 2014. The three were the <a href="https://www.theguardian.com/world/2021/jun/19/guinea-ebola-outbreak-declared-over-by-who">worst-affected countries</a> in an epidemic that lasted two years and led to over <a href="https://www.cdc.gov/vhf/ebola/history/2014-2016-outbreak/index.html">11,000 deaths</a>. </p>
<h2>Ratings reform</h2>
<p>The IMF recently announced a <a href="https://www.nytimes.com/2021/07/09/us/politics/g20-imf-vaccines.html">plan to issue US$650 billion</a> in reserve funds that low-income countries can use to buy vaccines and expand health care. While that should help more countries not to have to choose between credit ratings and the well-being of their citizens during the pandemic, it’s only a short-term fix.</p>
<p>A recent United Nations report <a href="https://undocs.org/A/HRC/46/29">urged reform of how private credit ratings agencies are regulated</a>, arguing they lack accountability and make it hard for poor countries to fulfill their human rights obligations. A proposal to put a moratorium on the sovereign credit ratings of debt-burdened countries during crises <a href="https://www.reuters.com/article/us-emerging-debt-ratings/credit-downgrade-buffer-proposed-for-poor-nations-seeking-debt-help-study-idUSKCN2DG0US">would also help provide a buffer</a>. </p>
<p>Permanent changes in how the IMF and private credit ratings agencies evaluate debt, however, may be needed so that they’re not penalizing countries for making important investments in health care and other public services. That would help countries can build their health care infrastructure so that they aren’t caught off guard by the next pandemic.</p>
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<p class="fine-print"><em><span>Ramya Devan does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Low-income countries that sought to spend more on health care during the pandemic have been hit with ratings downgrades, while others avoided borrowing entirely.Ramya Devan, Professor of Economics, Stockton UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1484582020-10-21T09:09:48Z2020-10-21T09:09:48ZWhy sovereign credit downgrades no longer matter as much as they used to<figure><img src="https://images.theconversation.com/files/364576/original/file-20201020-15-85szb3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Tall buildings, smaller credit rating. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/city-london-skyline-sunset-113828068">Jeremy Reddington</a></span></figcaption></figure><p>The decision by credit ratings agency Moody’s to cut the UK’s sovereign credit rating has <a href="https://www.ft.com/content/117349e4-dc95-4509-969b-26dcdede1773">been a gift</a> to the government’s critics. The <a href="https://www.theguardian.com/business/2020/oct/16/uk-credit-rating-downgraded-by-moodys-amid-growth-concerns">agency downgraded</a> the UK from Aa3 to Aa2 on the rationale that its heavy reliance on face-face services would mean that economic growth would be worse than expected because of the coronavirus pandemic.</p>
<p>Moody’s also cited the likelihood of either no Brexit trade deal or a narrow deal,
and <a href="https://www.ft.com/content/117349e4-dc95-4509-969b-26dcdede1773">said the UK</a> is going through the worst “peak to trough contraction” in the G20. It added that the quality of UK legislative and executive institutions, though still high, has “diminished in recent years”. </p>
<p>The downgrade <a href="https://tradingeconomics.com/country-list/rating">puts the UK</a> on the same credit rating as Belgium, the Czech Republic, Qatar and Hong Kong – three notches below Aaa nations like the US, Germany, Australia and Norway. The other leading agencies, S&P and Fitch, respectively rank the UK as AA and AA-. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Triple A credit rating melting" src="https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=359&fit=crop&dpr=1 600w, https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=359&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=359&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=451&fit=crop&dpr=1 754w, https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=451&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/364491/original/file-20201020-21-zp9m1n.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=451&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">A is for apprehension.</span>
<span class="attribution"><a class="source" href="https://www.visualcapitalist.com/chart-the-downward-spiral-in-interest-rates/">koya979</a></span>
</figcaption>
</figure>
<p>Yet the markets responded with a shrug. The <a href="https://uk.tradingview.com/symbols/TVC-BXY/">pound rose</a> on Monday October 19 after Moody’s made its announcement. Contrast that with the <a href="https://uk.reuters.com/article/us-markets-britain/moodys-downgrade-adds-momentum-to-investor-swing-away-from-pound-idUKBRE91O0OR20130225">sharp sell-off</a> when Moody’s originally downgraded the UK from Aaa in 2013. This reflects the fact that the new downgrade is unnecessary and happening in a world where ratings agencies’ views on many countries matter much less than before. </p>
<h2>The price of money</h2>
<p>When ratings agencies cut a country’s rating, it should prompt a sell-off in their sovereign bonds and drive up borrowing costs for the government. In the current interest rate environment, this is far less likely for wealthy countries like the UK. </p>
<p>After the 2007-09 financial crisis, central banks lowered their base rates and engaged in quantitative easing (QE). This is where they “print” money and buy up many government bonds (more recently also corporate bonds). This extra demand causes a shortage in bonds, driving up their prices and lowering the interest rate that issuers pay on them (the yield). The net result is that short-term and long-term interest rates are at <a href="https://www.visualcapitalist.com/chart-the-downward-spiral-in-interest-rates/">historic lows</a>.</p>
<p>In places like the eurozone and Switzerland, the base rate is even negative. This means that when governments issue bonds, they actually pay less than they borrowed. The same can be true for individuals taking out a mortgage – such as at Denmark’s <a href="https://www.theguardian.com/money/2019/aug/13/danish-bank-launches-worlds-first-negative-interest-rate-mortgage">Jyse Bank</a>.</p>
<p>The UK does not yet have negative interest rates, but the Bank of England <a href="https://www.theguardian.com/business/2020/oct/12/bank-of-england-negative-interest-rate-borrowing">may introduce</a> them soon. The bank <a href="https://www.hl.co.uk/news/articles/bank-of-england-what-100bn-in-extra-qe-means-for-investors">has also</a> been doing more QE in response to the pandemic. This is not a climate in which interest rates are likely to rise. </p>
<h2>The UK outlook</h2>
<p>If that is the general picture, could anything cause problems specifically for UK bonds? First would be a rise of inflation, but given the pandemic and subdued economic activity this is highly unlikely. Second would be a no-deal Brexit. Setting aside the political choreography, the two main sticking points are state aid and fishing. The two sides have softened their positions on both fronts, so there is a reasonable chance of some kind of deal. </p>
<p>Third would be a significant depreciation in sterling. This is unlikely as it <a href="https://uk.tradingview.com/symbols/TVC-BXY/">already happened</a> after the Brexit referendum. The fourth risk is international investors dumping British government bonds in favour of those of other western countries. Again unlikely, given that Europe and the US are in the same boat over coronavirus and public debt. </p>
<p>Fifth, investors could switch to Chinese government bonds. But there is a lack of transparency and depth in the Chinese bond market and, more importantly, the Chinese economy is export-oriented. In other words, it depends heavily on strong import demand, which the Europe and US are unlikely to offer consistently for some time. </p>
<p>Finally, there could be an outflow of capital from the UK to emerging markets. But emerging economies <a href="https://www.ft.com/content/b61c8dea-58bc-476d-ae9f-c2de104808de">are already</a> facing difficulties in servicing their borrowing.</p>
<h2>The big picture</h2>
<p>Moody’s reasons for downgrading the UK are not unreasonable in isolation. But in a broader context, the arguments about growth challenges apply to most of the developed economies to a lesser or greater extent.</p>
<p>Also, the UK’s debt to GDP ratio <a href="https://www.economicshelp.org/wp-content/uploads/2020/04/uk-national-debt-since-1727-annotated.png">is still well below</a> its historical peaks. It was in excess of 200% after the Napoleonic wars and second world war, whereas today it is a touch over 100%. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Charles II cartoon" src="https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=621&fit=crop&dpr=1 600w, https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=621&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=621&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=780&fit=crop&dpr=1 754w, https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=780&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/364497/original/file-20201020-16-1u95c09.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=780&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The great debt cavalier.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/charles-ii-242834821">Christiaan Lloyd</a></span>
</figcaption>
</figure>
<p><a href="https://theconversation.com/coronavirus-will-drive-public-debt-far-higher-than-expected-but-that-doesnt-mean-a-return-to-austerity-136295">It is true that</a> consumer and business debt are much higher than in previous generations, but the UK has not defaulted on its bonds <a href="https://oldcurrencyexchange.com/2015/08/20/financial-crisis-1676-as-charles-ii-defaults-on-royal-loans/">since the time</a> of Charles II. Add to this a strong legal system to re-assure investors of legal recourse if the UK did default. </p>
<p>More broadly, inflation could well remain low in a post-pandemic world, resulting in low interest rates for many years. Why not binge borrow, if it doesn’t cost anything in real terms and you can repay over a long period – or even pay back less than borrowed in real terms if inflation increases during the period of repayment? </p>
<p>Some governments are seeing this as a rare opportunity to revitalise their infrastructure. The UK government is ideally positioned to exploit this situation, since the average duration for its bonds to be repaid to investors <a href="https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/785550/debt_management_report_2019-20_final_web.pdf">is long</a>. </p>
<p>At the end of the day, institutions have to keep their money somewhere safe. They would ideally also like a healthy return, but safety may be more important than returns following the global financial crisis and pandemic. If so, government bonds are their best choice and UK bonds are among the best available. Demand for UK government bonds may therefore go up, further decreasing the cost of borrowing. </p>
<p>Moody’s analysis would have made sense prior to the 2008 financial crisis. It does not make sense in today’s world, with historically low interest rates, long average bond durations and public debt still manageable. In short, the downgrade will not have any impact on the UK’s ability to borrow. The agency has not considered the current context or the broader historical picture, and its assessments are not as relevant as they once were.</p><img src="https://counter.theconversation.com/content/148458/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ghulam Sorwar does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The first trading day after Moody’s cut the UK to three notches below Aaa, the markets shrugged.Ghulam Sorwar, Professor of Finance, Keele UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1466932020-10-20T09:15:28Z2020-10-20T09:15:28ZAfrican countries need reliable and accessible economic data: recent ratings show why<figure><img src="https://images.theconversation.com/files/364258/original/file-20201019-13-1ajxsgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Botswana retained its rating because of its strong case about fiscal strategy, institutional strength, and prudent policymaking</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>A number of African countries have recently been <a href="https://www.reuters.com/article/namibia-ratings-idAFL5N1KZ0GD">contesting</a> decisions by credit rating agencies. <a href="https://www.graphic.com.gh/business/business-news/government-unhappy-with-downgrading-by-s-p-global.html">Some</a> have raised objections that the rating agencies lack understanding of their economic environment. Others have <a href="https://www.lusakatimes.com/2015/09/28/ignore-moodys-credit-downgrade-on-zambia-government-tells-investors-and-the-public/">challenged</a> the correctness of their ratings on the basis that the agencies had not discussed them with the country’s representatives.</p>
<p>The United Nations has <a href="https://businessday.ng/financial-times/article/moodys-clashes-with-un-over-g20-debt-relief-efforts/">questioned</a> the timing and basis for rating downgrades. The eurozone rating watchdog – the European Securities and Markets Authority – has also <a href="https://webcache.googleusercontent.com/search?q=cache:aT5d8kFrigkJ:https://af.reuters.com/article/idUSL5N2BX383+&cd=1&hl=en&ct=clnk&gl=za">cautioned</a> agencies against deepening the coronavirus crisis through “quick-fire” downgrades of countries as the pandemic pushes economies into recession. The <a href="https://au.int/sites/default/files/documents/38893-doc-covid_19_final_english.pdf">African Union</a> has called for rating agencies to <a href="https://www.mofep.gov.gh/press-release/2020-09-14/global-ratings-lowers-ghanas-long-term-rating-to-b-with-a-stable-outlook">freeze downgrades</a> during the COVID-19 global pandemic.</p>
<p>But rating agencies <a href="https://www.ft.com/content/253210d5-4a2d-439f-a4a6-204a7f66d445?ftcamp=engage%2Femail%2Fnewsletters%2Fsmart_brief%2Fsmartbriefnewsletterscontrafcf%2Fauddev&segid=0800933">justify</a> their decisions on the basis of credible data that’s available.</p>
<p>There is indeed a problem when it comes to credible data. Most African countries lack <a href="https://www.economist.com/middle-east-and-africa/2020/05/07/lacking-data-many-african-governments-make-policy-in-the-dark">reliable and up-to-date data</a>. Where it is available, analysts and researchers have questioned its <a href="https://www.cgdev.org/blog/why-african-stats-are-often-wrong">accuracy</a>. </p>
<p>What this means is that governments are failing to convey sufficient and credible macroeconomic data and other important information to rating agencies and other interested parties. There is a dearth of information. Analysts have <a href="https://exxafrica.com/special-report-manipulation-of-economic-indicators-in-africa/">reported</a> instances of manipulation. </p>
<p>This has negative consequences for governments and the countries they run.</p>
<h2>Why good data matters</h2>
<p>Credible macroeconomic data and accurate information about how countries are running their finances is key to determining business confidence and market sentiment. If governments fail to ensure that financial markets can get reliable data, the public media assume this role. In turn, investors become more speculative.</p>
<p>Where credible data is unavailable, rating agencies make assumptions and estimate the key risk factors. These estimates can prejudice the risk profile of a country, especially if the lead rating analyst is pessimistic about the country’s economic outlook.</p>
<p>Rating agencies use a number of measures to determine a rating. They evaluate governance and institutional strength and they weigh economic and fiscal factors. They also assess the domestic political and geopolitical risks. In addition, they evaluate a country’s ability to withstand unforeseen shocks, commonly referred to as an event risk. </p>
<p>It’s a challenge for agencies to assess African economies’ susceptibility to event risks and the strength of their governance arrangements and institutions. </p>
<h2>Why access to policy information matters</h2>
<p>The African Peer Review Mechanism, set up as a way for African countries themselves to evaluate the legitimacy of rating drivers, <a href="https://au.int/sites/default/files/documents/38809-doc-final_africa_scr_review-_mid_year_outlook_-_eng.pdf">found</a> that a number of the rating decisions during the COVID-19 pandemic were simply a result of the information asymmetry between governments and rating agencies.</p>
<p>The following recent examples are evidence of asymmetries:</p>
<ul>
<li><p>Standard & Poor’s <a href="https://www.iol.co.za/business-report/economy/s-and-p-warns-sa-over-its-r500bn-coronavirus-stimulus-package-48478384">downgrade warning</a> to South Africa over its R500 billion coronavirus package. The rating agency believed the package could increase the country’s debt burden to unsustainable levels, weakening an already depressed economy. The <a href="https://www.businesslive.co.za/bd/opinion/2020-06-08-sps-assessment-of-the-countrys-covid-support-package-is-faulty/">problem</a> was that government had failed to emphasise that a huge chunk of the package – about R400bn – was productive spending on protecting jobs, creating employment and assisting business enterprises. Government should have highlighted how the net economic output of this productive expenditure would be beneficial to the larger economy. Combined with a plan for increasing efficiency in revenue collection, it would have addressed the concerns about rising debt.</p></li>
<li><p>Moody’s rating review for the downgrade of <a href="https://www.moodys.com/research/Moodys-places-Cameroons-B2-rating-on-review-for-downgrade--PR_425269">Cameroon</a>, <a href="https://www.moodys.com/research/Moodys-places-Cte-dIvoires-Ba3-ratings-on-review-for-downgrade--PR_425737">Côte d'Ivoire</a> and <a href="https://www.moodys.com/research/Moodys-places-Senegals-Ba3-ratings-on-review-for-downgrade--PR_426332">Senegal</a>, and downgrade of <a href="https://www.moodys.com/research/Moodys-downgrades-Ethiopias-rating-to-B2-rating-on-review-for--PR_423739">Ethiopia</a> because of their <a href="https://theconversation.com/why-african-countries-are-reluctant-to-take-up-covid-19-debt-relief-140643">participation</a> in the <a href="https://www.worldbank.org/en/topic/debt/brief/covid-19-debt-service-suspension-initiative">G20 Debt Service Suspension Initiative</a>. There were information gaps on the <a href="https://theconversation.com/why-african-countries-are-reluctant-to-take-up-covid-19-debt-relief-140643">nature and magnitude of risk</a> this initiative posed to private creditors.</p></li>
<li><p>Standard & Poor’s downgrade of Ghana because of <a href="https://www.modernghana.com/news/1030194/sps-rating-downgrade-on-ghanas-covid-19-expendi.html">one-off fiscal expenditure</a>. Ghana <a href="https://www.modernghana.com/news/1030194/sps-rating-downgrade-on-ghanas-covid-19-expendi.html">planned</a> to pursue fiscal consolidation after COVID-19 without accumulating high debt. Had government shown how the temporary increase in expenditure would not be such an economic burden, it would have addressed the rating agency’s concerns.</p></li>
</ul>
<h2>What’s missing</h2>
<p>A number of negative decisions could have been avoided through more transparency and communication between governments and rating agencies. </p>
<p>Regular meetings are key. Rating agencies typically have meetings with government officials, central banks and private sector representatives ahead of a ratings decision. The COVID-19 outbreak interrupted these. </p>
<p>There’s also the issue of the capacity of governments. There have been cases of government officials and other stakeholders who meet representatives of rating agencies <a href="https://au.int/sites/default/files/documents/38809-doc-final_africa_scr_review-_mid_year_outlook_-_eng.pdf">being inadequate</a> to the task. Governments must ensure that their teams can provide rating agencies with accurate information and explain inconsistencies in the data and policy direction that rating agencies pick up.</p>
<p>Two African countries stand out for having been able to demonstrate the soundness of their economic policy decisions during COVID-19.</p>
<p>Botswana, the only A-rated African country, <a href="https://www.moodys.com/research/Moodys-announces-completion-of-a-periodic-review-of-ratings-of--PR_425968">retained</a> its rating by Moody’s. Government made a strong case to rating agencies about its fiscal strategy, institutional strength and prudent policymaking.</p>
<p>Egypt <a href="https://www.moodys.com/research/Moodys-affirms-Egypts-B2-rating-outlook-stable--PR_424141">retained its B-rating</a>. It has opened several platforms to disseminate data on its improvements in governance and policy effectiveness. It is the only African country that issued sovereign bonds after the outbreak of the pandemic. The US$5 billion Eurobond issue was priced at substantially fair yields and was <a href="https://www.bloomberg.com/news/articles/2020-05-21/egypt-tests-limits-of-investor-appetite-with-eurobond-issuance">five times oversubscribed</a>. </p>
<h2>How data transparency can be achieved</h2>
<p>African governments need to invest more in collecting and sharing accurate data, which they must communicate to investors and rating agencies. </p>
<p>A good starting point would be the <a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/07/27/15/45/Standards-for-Data-Dissemination">data standards</a> set out by the International Monetary Fund. These are aimed at enhancing transparency, openness and credibility of data. They guide countries in how they should package their economic and financial data. Subscription to the standard is voluntary. All African countries but three – Somalia, South Sudan and Eritrea – subscribe to the <a href="https://data.imf.org/regular.aspx?key=61545852">data provision platform</a>. But most are still not supplying timely data.</p>
<p>Lastly, it’s important for African governments to engage rating agencies regularly. This is even more important during times of crisis so that rating agencies can be better informed about how governments are responding. Key individuals in government should also speak with one voice when communicating with the investing public. They should make the effort to regularly address all concerns being raised.</p><img src="https://counter.theconversation.com/content/146693/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Misheck Mutize is the Lead Expert consultant with the African Union - African Peer Review Mechanism (APRM) on supporting countries on their engagements with international credit rating agencies.</span></em></p>African governments must engage rating agencies better, providing them and investors with credible economic data, and regularly address all concerns being raised.Misheck Mutize, Post Doctoral Researcher, Graduate School of Business (GSB), University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1435532020-07-28T13:05:30Z2020-07-28T13:05:30ZThe IMF’s $4bn loan for South Africa: the pros, cons and potential pitfalls<figure><img src="https://images.theconversation.com/files/349884/original/file-20200728-15-19u89b5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's finance minister Tito Mboweni says the IMF loan will limit the country's economic vulnerabilities which have been exacerbated by COVID-19.</span> <span class="attribution"><span class="source">Gallo Images/Brenton Geach</span></span></figcaption></figure><p><em>The International Monetary Fund (IMF) has approved a R70 billion (US$4.3 billion) loan for South Africa to help the country manage the immediate consequences of the fallout from COVID-19. The Conversation Africa’s editor, Caroline Southey, asked Danny Bradlow to shed some light on what South Africans should expect.</em></p>
<h2>What conditions has the IMF attached to the disbursement?</h2>
<p>The IMF has provided the funding through its <a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/02/19/55/Rapid-Financing-Instrument">Rapid Financing Instrument</a>. This is designed to support countries facing an urgent need for financing due to a crisis such as the COVID-19 pandemic. The goal is to help the country face the immediate financial consequences of the crisis. As a result the IMF provides the financing quickly and without strict conditions. The country merely needs to show the IMF that it is facing a crisis, that it will use the funds to deal with the crisis, that it will cooperate with the IMF to solve the balance of payments problems caused by the crisis and to describe the economic policies that it proposes to follow. </p>
<p>In some cases, the IMF may require the country to undertake certain policy actions before it can access the funds.</p>
<p>In South Africa’s case, the country’s payments problem relates to the fact that the economy is expected to contract by about 7% this year and the budget deficit to increase to <a href="https://www.gov.za/speeches/minister-tito-mboweni-2020-supplementary-budget-speech-24-jun-2020-0000">about 15% of GDP</a>. This means that the government will need to increase the amount it has to borrow. Given that it has been <a href="https://www.fitchratings.com/research/islamic-finance/fitch-downgrades-south-africa-to-bb-outlook-negative-03-04-2020">downgraded</a> by <a href="https://www.reuters.com/article/safrica-ratings/moodys-downgrades-south-africa-sovereign-rating-to-junk-idUSL8N2BK8M5">credit rating agencies</a>, and that the economy is in bad shape, there is a substantial risk that both local and foreign investors will have a limited appetite for South African debt. This will complicate the government’s efforts to finance the deficit. </p>
<p>The IMF loan helps resolve this problem. </p>
<p>South Africa provided the requisite information to the IMF in the form of a letter of intent signed by the minister of finance and the governor of the Reserve Bank. The letter has not yet been made public. But, according to the <a href="https://www.imf.org/en/News/Articles/2020/07/27/pr20271-south-africa-imf-executive-board-approves-us-billion-emergency-support-covid-19-pandemic">IMF press release</a>, South Africa seems to have informed the IMF that it intends to take certain steps to stabilise the country’s finances. This means that the government will cut government spending to reduce its need to borrow. The current disputes over public sector wages and funding for state owned enterprises are examples of steps it could take. The government has also said it will improve the governance of state owned enterprises, and introduce reforms to stimulate a growing and inclusive economy. These reforms could include measures to improve competition in different sectors of the economy. </p>
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Read more:
<a href="https://theconversation.com/south-africans-should-accept-that-the-imf-is-neither-their-worst-enemy-nor-their-saviour-143199">South Africans should accept that the IMF is neither their worst enemy nor their saviour</a>
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<p>South Africa made these undertakings in last October’s <a href="http://www.treasury.gov.za/documents/mtbps/2019/mtbps/FullMTBPS.pdf">medium term budget statement</a> and in the supplementary budget statement in <a href="https://www.gov.za/speeches/minister-tito-mboweni-2020-supplementary-budget-speech-24-jun-2020-0000">June this year</a>. </p>
<p>This suggests that the IMF is merely expecting the country to implement the policies already announced by the government.</p>
<h2>How will the money be disbursed?</h2>
<p>This kind of financing is provided in one payment. The IMF press statement doesn’t say when the funds will be disbursed but the goal is to make the funds available “rapidly”. That could be as early as August. </p>
<p>Once the funds are disbursed, the government will be free to spend them. According to the national treasury’s <a href="https://www.gov.za/speeches/treasury-imf-approval-us43-billion-financial-support-south-africa-deal-coronavirus-covid-19">statement</a>, it plans to use the money to support health and frontline services, to protect the vulnerable, drive job creation, support economic reform and stabilise public debt. </p>
<p>These are all consistent with the purpose of the Rapid Financing Instrument and the government’s stated intentions. </p>
<p>But these purposes are very general and we will need to see more detail about what exactly the government will spend the funds on.</p>
<h2>What restrictions are there on the government’s ability to use the money?</h2>
<p>The IMF loan <em>does not</em> impose any conditions over and above what is in South African law on how the funds can be used. Consequently, the funds will be subject to the same procurement and accounting requirements as all other budgetary expenditure. </p>
<p>In addition, the government will have to account in its future budget statements and reports to parliament on how the funds have been used. South Africans will also be able to demand that the government demonstrate that the funds have been spent consistently with the requirements of the constitution and bill of rights. This means the government should show that it is using the maximum available resources, from whatever source, to help realise all the rights that the constitution and South Africa’s international commitments grant to South Africans.</p>
<p>The IMF requires that South Africa repay the funds to the IMF over 20 months beginning 40 months after the loan is disbursed. This means that South Africans will need to ensure that the funds to repay the IMF are properly budgeted for.</p>
<h2>What are the upsides of the loan?</h2>
<p>The most important benefit is that South Africa is getting $4.2 billion at about 1.1% interest. This is a very cheap source of funds. If the government tried to raise the same amount either on domestic markets or from other international sources it would pay a considerably higher interest rate – the current rate for government bonds of comparable maturity is about <a href="http://www.worldgovernmentbonds.com/country/south-africa/#:%7E:text=The%20South%20Africa%2010Y%20Government%20Bond%20has%20a%209.155%25%20yield.&text=Normal%20Convexity%20in%20Long-Term,last%20modification%20in%20July%202020">7%</a>.</p>
<p>The second potential benefit is that the IMF loan will catalyse other funds for the country. In other words investors in South Africa and abroad will interpret the IMF’s action as an expression of support for South Africa and this will give them the confidence to invest in South African debt. Given that foreign investors hold about <a href="https://sec.report/Document/0001104659-20-044565/">30% of South African government’s rand denominated debt</a> this boost to confidence could be important. It will both reduce the incentive of these investors to sell their government bonds, potentially pushing up interest rates, and enable the government to issue new debt if needed.</p>
<p>The third benefit is that by helping to stabilise South Africa’s situation, it will limit the damage that may be inflicted on the neighbouring countries. This, in turn, could help South African exports and thus help preserve jobs and income in South Africa.</p>
<h2>What are the downsides?</h2>
<p>The most significant downside is that the loan is denominated in foreign exchange. Thus South Africa has to bear the risk that if the rand depreciates, the loan and the interest on it will become more expensive. Given the state of the South African economy, this is not an insignificant risk. </p>
<p>But it’s important to keep in mind that the IMF denominates the loan and the repayment obligations in Special Drawing Rights. These are the IMF’s special form of money and its value is made up of a composite of a basket of currencies. These include the US dollar, the euro, the Japanese yen, the Chinese renminbi and the pound sterling. The values of these currencies tend to fluctuate against each other so that some appreciate while others depreciate. This helps mitigate the foreign exchange risk that South Africa must bear.</p>
<p>The second risk is that if South Africa does not use the funds from the IMF wisely, the country’s economic situation will deteriorate and it will struggle to pay back the debt. </p>
<p>If this happens or the pandemic lasts longer than anticipated, the country could be forced to seek additional support. In either case South Africa’s negotiating position would be significantly weaker.</p><img src="https://counter.theconversation.com/content/143553/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Danny Bradlow's SARCHI chair is funded by the National Research Foundation. He also has a grant from the Open Society Initiative of Southern Africa (OSISA) for a project on sovereign debt in the SADC region. </span></em></p>The IMF loan does not impose any conditions over and above what is in South African law on how the funds can be used; it only seems to expect the country to implement policies already announced.Danny Bradlow, SARCHI Professor of International Development Law and African Economic Relations, University of PretoriaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1391772020-06-02T12:22:08Z2020-06-02T12:22:08ZAttack of zombie companies: don’t let them eat bailouts that are vital to restore the economy<figure><img src="https://images.theconversation.com/files/337029/original/file-20200522-124851-fw185l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">shutterstock</span> </figcaption></figure><p>Governments are all deciding which struggling companies to help out in the COVID-19 pandemic. Among the many looking for help, some have a strange deathly pallor. </p>
<p>This is nothing to do with whether they trade in sectors whose futures look very uncertain – though many do. For years, these companies have been struggling to pay the interest on their large debts, let alone the principal, despite the long period of very low interest rates. Some were on their way to failure. The buoyant economy before coronavirus kept them just about stumbling along. </p>
<p>There are many of these zombies in our midst, and whatever public money they receive means less available for firms that were healthy before the pandemic. Morgan Stanley <a href="https://www.ft.com/content/cc31fe38-8adb-11ea-9dcb-fe6871f4145a">estimates that</a> as many as 16% of US companies are zombies, while there are plenty in <a href="https://asia.nikkei.com/Spotlight/Datawatch/Asia-s-zombies-concentrated-in-India-Indonesia-and-South-Korea">Asia</a> and <a href="https://www.finanzen.ch/nachrichten/konjunktur/euler-hermes-auf-unternehmen-rollt-wegen-corona-pleitewelle-zu-1029186352">Europe</a> too. </p>
<h2>Bad medicine</h2>
<p>Various countries <a href="https://www.ft.com/content/26af5520-6793-11ea-800d-da70cff6e4d3">have given financial aid</a> to the private sector in recent months, including extending credit and grants to companies. More aid is likely on the way. As more and more companies run into trouble, governments will have to decide when and how to step in. </p>
<p>Even in better times during the last three years, <a href="https://www.uscourts.gov/news/2019/04/22/bankruptcy-filings-continue-decline">US bankruptcies averaged</a> 23,000 firms per year. Some of them may have failed because of zombie firms, since <a href="https://oecdecoscope.blog/2017/12/06/zombie-firms-and-weak-productivity-what-role-for-policy/">research suggests</a> they crowd out credit from other candidates even in the best of times. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=803&fit=crop&dpr=1 600w, https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=803&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=803&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1009&fit=crop&dpr=1 754w, https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1009&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/337033/original/file-20200522-124860-pydv9a.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1009&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Joseph Schumpeter: life through death.</span>
<span class="attribution"><a class="source" href="https://en.wikipedia.org/wiki/Joseph_Schumpeter#/media/File:Joseph_Schumpeter_ekonomialaria.jpg">Wikimedia</a></span>
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</figure>
<p>In normal circumstances, however, business failures are actually good for society – tragic as they are for business owners and their employees. The victims are able to take risks and try new things, without which there can’t be progress. This “creative destruction”, as the Austrian economist Joseph Schumpeter <a href="https://www.nytimes.com/2000/06/10/your-money/IHT-half-a-century-later-economists-creative-destruction-theory-is.html">described it</a>, is a necessary part of capitalism. Governments and central bankers rightly fight the effects of recessions on citizens – this year’s cash payments to American workers <a href="https://www.brownadvisory.com/us/cares-act-first-look#:%7E:text=The%20CARES%20Act%20provides%20almost,affect%20businesses%20and%20individuals%2C%20and">would be an example</a> – but recessions are often necessary corrections to over-exuberance in business. </p>
<p>So while the pandemic is very unusual, in one sense we must view it like any recession. For this reason, governments don’t need to worry about the business failure rate but about the excess failure rate – for example, US bankruptcies <a href="https://tradingeconomics.com/united-states/bankruptcies">hit around</a> 60,000 firms in 2010, so that may be a useful yardstick this time around. </p>
<h2>Zombie handling</h2>
<p>The US government, among others, has left itself open to propping up zombies by <a href="https://www.clearygottlieb.com/news-and-insights/publication-listing/president-signs-cares-act-emergency-relief-provided-to-businesses-and-consumers">offering emergency relief</a> to all struggling businesses, regardless of their financial picture before the pandemic. <a href="https://www.ft.com/content/0467d0e1-6814-4cc4-ad4b-e25c80169466">The rush</a> of American small businesses to access funding illustrates how quickly money can move in the wrong direction. It demonstrates the need to think out the rules carefully in advance. </p>
<p>It would have been smarter to focus on mechanisms that choose between struggling businesses. Whereas under the emergency relief programme, banks lend to any business knowing the government will cover the debts, one option for the future is to just to stimulate bank lending and let banks choose who to lend to. This way they have skin in the game and the weak can be allowed to fail. </p>
<p>Another option would be to let vulnerable companies work themselves out in the normal bankruptcy reorganisation process (Chapter 11 in the US, administration <a href="https://www.thegazette.co.uk/all-notices/content/100263/">in the UK</a>). For example, the biggest US airlines <a href="https://www.bloombergquint.com/onweb/u-s-airlines-spent-96-of-free-cash-flow-on-buybacks-chart">spent almost all</a> their free cash flow on share buybacks over the last decade, sometimes going heavily into debt to do so. This benefited their shareholders and bondholders, so it’s appropriate that they take the hits. Once a company has been reorganised, government aid could then be made available to prop up the “good” parts that remain. </p>
<p>Some will argue that certain firms are too big to fail. Japan resisted letting their big companies die in the “lost decade” of the 1990s, but when it did the economy improved. South Korea had a <a href="https://www.economist.com/business/1999/08/19/the-death-of-daewoo">similar experience</a> with Daewoo. </p>
<p><a href="https://milestalk.com/virgins-airlines-on-brink-of-collapse-branson-offers-necker-island-as-loan-collateral/">Some have tried to make</a> the same argument about Virgin Atlantic being too big to fail today. A look at the financials suggests the UK government was likely correct to <a href="https://simpleflying.com/virgin-atlantic-interest/">initially reject</a> its request for £500 million in state aid, especially as Virgin had not tried to seek investments from other sources. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/339153/original/file-20200602-133892-1q0v66.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Too big to fail?</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/manchester-united-kingdom-april-21st-2018-1077136793">Craig Russell</a></span>
</figcaption>
</figure>
<p>The airline <a href="https://www.ft.com/content/fe163e1a-5b7e-11e9-9dde-7aedca0a081a">lost money</a> in 2017 and 2019 and warned a year ago that it would not make a profit for at least another two years because of Brexit and high fuel costs. Owner Richard Branson is now trying to put together private funding of around £450 million on the basis that he can then reapply for government assistance. He shouldn’t be given that assistance. In any case, it <a href="https://www.theguardian.com/business/2020/may/11/richard-branson-to-sell-500m-worth-of-virgin-galactic-shares">may be unnecessary</a> if he sells some of his other business interests. </p>
<p>One country that has some protection against zombie firms is Germany. Before a company can receive funding from state-owned German bank KfW, the authorities <a href="https://www.dertreasurer.de/news/finanzen-bilanzen/kfw-coronahilfen-die-4-wichtigsten-punkte-fuer-treasurer-2013021/">must be satisfied</a> that it was in solid shape before the crisis. This could be a useful model for other countries. </p>
<p>In short, the best way to help the economy is either to let zombie companies resurrect themselves through the bankruptcy process or just return to the grave. Yes, there will be economic pain if these companies fail – including job losses. But rather than providing government aid to these zombies, it might be better directed at their former employees. For example, the Swiss government <a href="https://www.swissinfo.ch/eng/covid-19_coronavirus--the-situation-in-switzerland/45592192">is putting</a> more money into unemployment insurance. Feeding zombies will just make the recovery longer and slower, crowding out more worthy enterprises and wasting resources.</p><img src="https://counter.theconversation.com/content/139177/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Earle is the owner of Alea IE, LLC, an economics consultancy firm in San Francisco.</span></em></p><p class="fine-print"><em><span>Jung Park and Karl Schmedders do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>They stumble around, baying for assistance, hoping to drink the lifeblood of other companies’ financial aid.Robert Earle, Lecturer in Management, University of ZurichJung Park, Research Fellow in Data Science, International Institute for Management Development (IMD)Karl Schmedders, Professor of Finance, International Institute for Management Development (IMD)Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1230442019-09-08T18:37:46Z2019-09-08T18:37:46ZHow green are green bonds? Ratings can help investors know<figure><img src="https://images.theconversation.com/files/291123/original/file-20190905-175682-zn6itl.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">shutterstock</span> </figcaption></figure><p>Since the Industrial Revolution, humans have invested in machines and other technologies to help them increase productivity and improve their lives. Unfortunately, one of the side effects of many of these advances is that we’re now grievously damaging the planet. </p>
<p>We’re now reconsidering our relationship to the environment, as demonstrated by <a href="https://www.fridaysforfuture.org/">Greta Thunberg and the Fridays for Future movement</a>, but an even bigger revolution is what’s required. The International Energy Agency (IEA) estimates that cumulated costs of approximately 50 trillion USD are needed <a href="https://www.iea.org/publications/freepublications/publication/WEIO2014.pdf">until the end of 2035</a> to significantly lower our CO<sub>2</sub> emissions and reach the goals of the <a href="https://unfccc.int/process-and-meetings/the-paris-agreement/what-is-the-paris-agreement">2015 Paris Agreement</a>.</p>
<h2>Are green bonds part of the solution?</h2>
<p>The necessary investments in energy efficiency and CO<sub>2</sub> and carbon-emission savings are large, but the financial market has already begun to promote investments in sustainable projects. One possible solution are “green bonds”, which are earmarked for climate and environmental projects. Green bonds are not new: in 2007 a <a href="https://theconversation.com/as-big-business-goes-green-green-bonds-ready-for-takeoff-52294">“climate awareness bond”</a> was issued by the European Investment Bank. However, the number and the volume of green bonds has massively increased since the first issue. As of today, <a href="https://www.climatebonds.net/green-bond-segments-stock-exchanges">14 international stock exchanges</a> have launched a dedicated green bond section.</p>
<p>The advantage of green bonds is that companies can focus on sustainable projects and investors can support them. <a href="https://www.mdpi.com/2071-1050/11/4/1098">Research shows</a> that green bonds may even enjoy a negative premium compared to their “brown” peers and thus can be financed less expensively.</p>
<p>While it sounds straightforward, the main issue lies in the general character of the bonds. A green bond has the sustainable aspect, but no other differences from conventional ones. Bonds represent a form of debt financing from investors to borrowers, but the borrower can be various, and all companies can be potential issuers. Currently, most of the issuers are sovereigns and development banks, but also companies, such as <a href="https://www.apple.com/newsroom/2019/04/apple-tops-clean-energy-goal-with-new-supplier-commitments/">Apple</a>, release green bonds. Theoretically, it would be possible that firms from pollution-intensive industries issue ostensibly “green” bonds. As the cash from the bond goes directly into the hands of the firm, it is important to define the use of proceeds. The International Capital Market Association (ICAM) developed <a href="https://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/June-2018/Green-Bond-Principles%20--%20-June-2018-140618-WEB.pdf">Green Bond Principles</a> which are voluntary process guidelines.</p>
<h2>Labeling and greenwashing</h2>
<p>The voluntary process shows that there are currently no hard definitions what is a green bond or what is a sustainable investment. The market is not standardized; therefore it can be very hard to define what is green and what is not. Market standards and certifications could be one important aspect to increase the popularity of this segment while building the investors’ trust. The European Commission is currently working on an <a href="https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/190306-sustainable-finance-teg-interim-report-green-bond-standard_en_0.pdf">Action Plan on Financing Sustainable Growth</a> to set a comprehensive strategy to further connect finance with sustainability.</p>
<p>Bonds that are issued in the green segment of big stock exchanges, such as the London Stock Exchange, need to have a green label which must be certified by an agency. An independent party has to confirm the green character of the bond. From the investor’s side, besides regular reporting, a label might be a good guaranty that their money is invested in sustainable projects. The question that now arises is who has the competencies to issue green labels. A third party that is certifying the green character of the investment might just give labels to <a href="https://www.investopedia.com/terms/g/greenwashing.asp">greenwash</a> conventional bonds. If there is not enough transparency in the green labels and green labeling agencies start a market competition, the quality might be affected. The agency with the easiest requirements might win the battle and low standards would be established.</p>
<h2>The race for the pole position</h2>
<p>Besides the certification of the green bond character from a third party, investors want to know more about the sustainable character of a company. It can be very difficult to assess and compare the sustainability level of a company. Similar problems can be found in the past. More than 100 years ago, people who invested in railroad bonds were not able to calculate the probability of default. They asked John Moody whether he could rank the probability of default, and from this the credit-rating market arose. However, the market is associated with several issues, <a href="https://theconversation.com/credit-ratings-old-risks-and-new-challenges-for-financial-markets-118081">from regulatory aspects to agency problems</a>. It is quite likely that the “green labelling” or “sustainable rating” market will have similar issues. The question is whether and how we can learn from the past.</p>
<p>The market for green and sustainable finance is rapidly growing, and a number of <a href="https://cbey.yale.edu/sites/default/files/Responsible%20Investing%20--%20Guide%20to%20ESG%20Data%20Providers%20and%20Relevant%20Trends.pdf">environmental, social, and governance" (ESG) rating agencies</a> have established themselves. Their business model is similar to that of established firms such as Moody’s or Standard & Poor’s, but their analytical approach can vary. Some companies have a background in collecting data and they mainly use the market ones, such as Bloomberg or MSCI. Others, such as Sustainalytics, are ESG-exclusive data providers, have an approach similar to classical rating agencies and provide unique methodologies to assess the ESG quality of a firm. Finally, there are also other companies that focus on specific targets among the three aspects of ESG.</p>
<p>ESG ratings and classical credit ratings also have in common the possible risk for the rated company. If the firm receives a poor ESG rating, investors might refrain from buying equity, and sales could also fall. BP and Volkswagen are good examples of what happens if your ESG score is suddenly lowered.</p>
<h2>Who are the new players on the market?</h2>
<p>Regulators and investors have to start thinking now whether and how they want to establish green-label institutions and agencies as new players in the financial market before they become too important to be regulated. Alternative concepts to the business model of classical rating agencies already exist. It might be possible that ESG criteria are not rated by individual analysts but rather from a group of (independent) experts. <a href="https://www.impaakt.com/">Impaakt</a>, for example, just started an alternative service using a crowd-based approach.</p>
<p>The big question is what will be the standard definition of ESG criteria in the future. For example, if an oil company is labelled as “ecological” because it has a reduced energy consumption, does this really mean that it is ecological? ESG investing should be transparent and therefore it is important that ESG ratings methodology behind follow a holistic approach based on regulated methodologies.</p><img src="https://counter.theconversation.com/content/123044/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Florian Kiesel ne travaille pas, ne conseille pas, ne possède pas de parts, ne reçoit pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'a déclaré aucune autre affiliation que son organisme de recherche.</span></em></p>Since the first “climate awareness bond” was issued in 2007, the green-bond market has flourished. But how can investors judge their risk and effectiveness?Florian Kiesel, Assistant Professor of Finance, Grenoble École de Management (GEM)Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1185442019-06-11T09:40:46Z2019-06-11T09:40:46ZBoris Johnson’s threat to not pay Britain’s Brexit bill is dangerous for the UK economy<p>The frontrunner in the Conservative Party leadership contest, Boris Johnson <a href="https://news.sky.com/story/boris-johnson-i-wont-pay-39bn-unless-eu-gives-britain-better-exit-terms-11738084">announced</a> that, if elected to be the UK’s next prime minister, he would refuse to pay the UK’s Brexit divorce bill unless better withdrawal terms are on offer from the EU. This £39 billion bill is the amount agreed <a href="https://theconversation.com/the-brexit-divorce-bill-explained-74466">to settle the UK’s obligations</a> towards the EU budget and includes future spending commitments by the EU in Britain, beyond any exit date. </p>
<p>Johnson’s intention took most people – colleagues and EU counterparts alike – by surprise. Europe <a href="https://uk.reuters.com/article/uk-britain-eu-johnson-france/uk-not-paying-brexit-bill-would-be-debt-default-french-source-says-idUKKCN1TA0NU">responded immediately</a> to say that such an action would be considered a sovereign default by financial markets. While it’s hard to say if this will be the legal outcome of not paying, it’s safe to say it would seriously affect the UK’s finances and international standing.</p>
<p>Not honouring payment commitments isn’t something that developed countries are known for – especially not a G7 economy and leading financial centre like the UK. Not all debts are the same, however, and not all defaults have the same consequences. </p>
<p>Missing a payment owed by a state could technically be considered a sovereign default. But the answer as to what really happens as a result would be hidden in thousands of contractual terms and conditions and in the rules of credit reference agencies. Reneging on the Brexit divorce bill may be similar to the experience of the last developed country economy to experience a default event: Greece.</p>
<h2>Lessons from Greece</h2>
<p>At the end of June 2015 Greece became the first developed country in history to default to the International Monetary Fund, by failing <a href="https://money.cnn.com/2015/06/30/news/economy/greece-imf-default/index.html">to make a €1.5 billion payment</a>. Before the missed payment, rating’s agency Fitch had downgraded Greece, <a href="https://www.telegraph.co.uk/finance/economics/11709473/Greece-defaults-on-the-International-Monetary-Fund-after-launching-11th-hour-attempt-to-agree-new-rescue-deal.html">citing</a> the country’s breakdown in talks with the EU and the threat of a disorderly and permanent break from the eurozone’s payment system. </p>
<p>Nonetheless, default to the IMF did not constitute a “sovereign default” in the eyes of rating agencies and did not trigger a series of cross-default clauses on the country’s other outstanding debt. So if the Greeks got away with it, why shouldn’t the UK?</p>
<p>Unlike <a href="https://www.newstatesman.com/politics/2015/03/nation-states-arent-households-debating-their-economies-if-they-are-stupid">frequent attempts</a> to explain state finances through the lens of home economics, a nation’s balance sheet is not like one’s personal bank account. Nations owe large sums to a variety of private and institutional creditors, and this is normal. It is also normal to run significant budget deficits and finance a large volume of public debt. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/278728/original/file-20190610-52739-1b3ahvn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/278728/original/file-20190610-52739-1b3ahvn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/278728/original/file-20190610-52739-1b3ahvn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/278728/original/file-20190610-52739-1b3ahvn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/278728/original/file-20190610-52739-1b3ahvn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/278728/original/file-20190610-52739-1b3ahvn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/278728/original/file-20190610-52739-1b3ahvn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Britain should learn from Greece’s debt default.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/greek-flag-against-sun-dark-clouds-531556552?src=U_nQ4huwA4InjXbKiqhJAQ-4-23&studio=1">Shutterstock</a></span>
</figcaption>
</figure>
<p>General UK government gross debt was £1,837.5 billion at the <a href="https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicspending/bulletins/ukgovernmentdebtanddeficitforeurostatmaast/december2018">end of 2018</a>, equivalent to 86.7% of its gross domestic product (GDP). And the UK deficit (or net borrowing) was £32.3 billion in 2018, equivalent to 1.5% of its GDP. </p>
<p>While these amounts sound frightening, the UK has no problem borrowing money from markets, paying a mere <a href="https://www.bloomberg.com/markets/rates-bonds/government-bonds/uk">1% interest</a> on its five year bonds, for example. But these low borrowing rates are a consequence of the UK’s good <a href="https://tradingeconomics.com/united-kingdom/rating">credit rating</a>, which has been largely unaffected by uncertainty over Brexit.</p>
<h2>Junk status</h2>
<p>Where Johnson’s new government would run into trouble is that, by defaulting on its Brexit bill payment, it would likely suffer a blow to its credit rating. Greece’s drop from the top to the junk status of <a href="http://www.worldgovernmentbonds.com/credit-rating/greece/">credit ratings</a> during 2015 led it to complete reliance on institutional lenders for its funding needs. When a country is in tense negotiations with the same institutions on which it entirely relies on for its everyday funding, you can imagine what this means in terms of <a href="https://www.huffingtonpost.co.uk/entry/boris-for-pm-varoufakis-without-the-leather_uk_5ce80f6fe4b0ebf79ad33ce2">negotiating</a> power.</p>
<p>Whether a default on the Brexit divorce bill would merely put pressure on UK ratings, or whether it would plunge them to junk status is hard to predict. Yet, what is known is that any type of default event makes borrowing more costly, sucking funds away from public spending. This cannot be good for the UK treasury or the country. </p>
<p>In a worst case scenario, not paying the Brexit bill could result in a sovereign default and trigger cross-default clauses on a variety of financial products. Then the UK would face an immediate funding gap and be called to pay back immense amounts of money – this would severely hurt the economy. Just ask anyone from Argentina, which has gone through numerous defaults and is <a href="https://www.forbes.com/sites/jonhartley/2014/08/04/argentinas-default-lessons-learned-and-what-happens-next/#6a796d592384">struggling to recover</a>.</p>
<p>Considering that <a href="https://www.nytimes.com/2019/02/24/world/europe/britain-austerity-may-budget.html">almost everyone acknowledges</a> the difficulties created by the austerity drive of Conservative governments since 2010, it is unlikely that a sharp contraction in public spending due to borrowing difficulties would be positively received by the British public. Add to this the disruption to trade and manufacturing caused by a <a href="https://theconversation.com/no-deal-brexit-experts-on-what-the-uk-governments-advice-means-102074">no-deal Brexit</a> (which would accompany not paying the divorce bill), and the UK could face a very unpleasant Autumn indeed.</p><img src="https://counter.theconversation.com/content/118544/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ioannis Glinavos does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It’s hard to say if, legally, not paying the Brexit bill will classify as a sovereign default. But credit agencies will take serious notice.Ioannis Glinavos, Senior Lecturer in Law, University of WestminsterLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1180812019-06-10T19:54:48Z2019-06-10T19:54:48ZCredit ratings: old risks and new challenges for financial markets<figure><img src="https://images.theconversation.com/files/277206/original/file-20190530-69051-1c2iec6.jpg?ixlib=rb-1.1.0&rect=0%2C167%2C3029%2C1991&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Office of the Moody's Corporation ratings agency.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/new-york-nysept-4-2010-lettering-1325833637?src=qfgprk1n3TgZdNhW2-5vSA-2-42">Daniel J. Macy</a></span></figcaption></figure><p>In 2019, Moody’s Corporation, the holding company of Moody’s Investors Service, is celebrating its <a href="https://www.moodys.com/Pages/atc001.aspx">110th birthday</a>. Being the first rating agency and creator of a completely new industry, Moody´s is still successful today – in 2017, it generated $1 billion net income. However, since its foundation, the financial system has dramatically changed, and important issues have been raised about credit-rating agencies (CRAs) and their business model.</p>
<p>Even though Moody’s, Standard & Poor’s (S&P) and other CRAs have a successful past, today they face critics and the future of credit ratings has to be considered. Following the financial crisis in 2008 and the European debt crisis, criticism on CRAs rose. According to the <a href="https://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf">Financial Crisis Inquiry Commission</a>, CRAs were “key enablers of the financial meltdown” in 2008. The sovereign downgrade of major Eurozone economies additionally <a href="https://www.cfr.org/backgrounder/credit-rating-controversy">“accelerated the Eurozone’s sovereign debt crisis”</a>.</p>
<h2>A long history</h2>
<p>The concept of the credit rating scale was already introduced in 1909 and has not been changed over the last decades, even though the financial market has. The simplicity of the scale, which combines letters and numbers in a <a href="https://www.moodys.com/sites/products/AboutMoodysRatingsAttachments/MoodysRatingSymbolsandDefinitions.pdf">range from Aaa (the best) to C (default)</a>, is easily usable by the market. The rating scales differ slightly between the agencies, but generally more letters followed by lower numbers express a better rating. Moody’s ratings between AAA and Baa3 are considered as investment grade and have a low probability of default while ratings from Ba1 have a “junk” status and higher probabilities of default. The classification can be understood even without a deep knowledge of finance, one reason why it remained so successful over decades.</p>
<p>The importance of credit ratings has increased due to changes in the regulation. In 1975 the Security and Exchange Commission (SEC) issued new rating-based rules which established bank and broker-dealer capital requirements. The SEC additionally required that these ratings must have been issued by Nationally Recognized Statistical Ratings Organizations (NRSRO). Seven rating agencies were originally approved as NRSRO and today their number includes only three more.</p>
<p>The market is dominated by Moody’s and S&P. Their combined <a href="https://www.sec.gov/ocr/reportspubs/annual-reports/2017-annual-report-on-nrsros.pdf">US market share is approximately 83% (Moody’s 34.2%, Standard & Poor’s even 48.9%)</a>, with similar figures for <a href="https://www.esma.europa.eu/press-news/esma-news/esma-reports-annual-market-share-credit-rating-agencies">Europe</a>. Thanks to their long experience, they have a unique expertise in evaluating firm risk and new agencies struggle to compete with this knowledge. In addition, both companies have a solid reputation in the financial markets and the usage of smaller agencies could be interpreted as suspicious. Fitch Ratings was able to establish itself as the third biggest party, with a market share of around 13%. Fitch’s credit rating is especially important when the ratings of Moody’s and S&P differ from each other because it serves <a href="https://www.jstor.org/stable/41419673">as a tiebreaker</a>.</p>
<h2>New payment models… thanks to the photocopier</h2>
<p>Another significant change for the rating industry occurred in the beginning of the 1970s. In the original business idea, the investors needed to know the default probability and therefore they were charged for the service. However, when the prices for photocopy machines dropped, the <a href="https://www.washingtonpost.com/archive/business/2002/01/31/do-rating-agencies-make-the-grade/9482b73e-5199-40b2-985f-8f3c3084b8f4/?noredirect=on&utm_term=.934ff964c8fc">issued rating reports could be copied easily</a> and be accessible to all investors free of charge. Rating agencies had to change the payment model: bond issuers became the ones that had to pay, as they were required by law to have issuer ratings.</p>
<p>Referring to the new “issuer pays” model, Lynn Stout, Professor of Corporate and Securities Law at the University of California states: <a href="https://www.wsj.com/articles/SB10001424052748703814804576036094165907626">“When the people being watched get to choose their watchdog, they’re not going to choose the toughest animal around”</a>. Regulators tried to change this payment model, whose problems become even more prominent in times of stress, such as financial crises. In addition, <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2002186">research found</a> that the difference in ratings between “issuer pays” and “investor pays” is more pronounced when the conflict of interest is particularly severe.</p>
<h2>Should issuers or investors pay?</h2>
<p>The “issuer pays” model might lead to “rating shopping”, a situation in which the issuer contacts different agencies and chooses the one with the most favourable rating. Especially when the asset is complex to evaluate and ratings differ, the issuer has an incentive to choose only the best rating. This happened, for example, with CDOs (Collateralized Debt Obligations) tranches and triggered the financial crisis in 2008. Agencies rated risky bonds with good ratings in an attempt to <a href="https://ftalphaville.ft.com/2008/10/23/17359/rating-cows/">gain more business</a>. The “issuer pays” model is still the predominant type of payment and Moody’s, S&P and Fitch use this model, while only three of the 10 recognized agencies apply the “investor pays” model. For example, the rating agency Egan-Jones, founded in 1995, entered the market and is increasing its market share continuously thanks to this concept.</p>
<p>Another concern on CRAs consists of the rating analysts. The exact methodology of how CRAs evaluate the creditworthiness of issuers is a firm’s secret to avoid copies. The credit risk is evaluated through the <a href="https://www.moodys.com/sites/products/ProductAttachments/Exhibit2.pdf">application of quantitative and qualitative factors</a>. Therefore, ratings express the CRA’s opinion and are dependent on the analysts themselves. Research recently found subjectivity in ratings issued by the same firm. <a href="https://www.sciencedirect.com/science/article/pii/S0304405X1630006X">Analysts can be optimistic or pessimistic and this can be reflected in their decision</a>. This consequently leads to a rating bias that can have serious consequences. As an example, during the financial crisis analysts were often too optimistic while analysing default risk and the market followed their advices.</p>
<p>The last and probably the main challenge for CRAs lies in the changes of regulations which are due to the arising scepticism on their regards. In the last decade, several regulatory changes affected the rating industry. The most important one was the Dodd-Frank Act, signed into US law in 2010 in response to the financial crisis. The Dodd-Frank Act increased the liability for issuing inaccurate ratings and <a href="https://www.sciencedirect.com/science/article/pii/S0304405X14002347">made it easier to sanction CRAs in case of material misstatements or fraud</a>.</p>
<h2>Market data is the key in future</h2>
<p>Currently, CRAs are backed by the need of the financial markets because companies need to have at least one credit rating issued by a NRSRO in the case they want to issue a bond. CRAs indicate the opinion of the creditworthiness of firms, in particular of bond issuers. What happens if this would no longer be the case? In the past 20 years, alternative market instruments have provided similar information. Several researchers show <a href="https://www.emeraldinsight.com/doi/abs/10.1108/JRF-09-2016-0119?fullSc=1&journalCode=jrf">that credit default swaps (CDS) spreads can be used to extract implied credit ratings</a>.</p>
<p>CDS data help to get more information about the issuer from a market perspective. Implied credit ratings have the advantage to be independent of analysts and are based on the opinion on the bond market participants themselves. The question is whether these market implied ratings – or other new instruments – will replace the CRA’s traditional ratings. The Big Three – Moody’s, S&P and Fitch Ratings – have already established market-based ratings, using data from the CDS market. A better integration between market data and the judgement of analysts could in the future lead to more balanced ratings.</p><img src="https://counter.theconversation.com/content/118081/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Florian Kiesel ne travaille pas, ne conseille pas, ne possède pas de parts, ne reçoit pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'a déclaré aucune autre affiliation que son organisme de recherche.</span></em></p>Standard & Poor’s, Moody’s, and other ratings agencies have a long and storied history, but today they face significant criticism and the future of ratings themselves are under challenge.Florian Kiesel, Assistant Professor of Finance, Grenoble École de Management (GEM)Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1024192018-08-31T11:11:33Z2018-08-31T11:11:33ZWonga’s collapse and what it means for the people who rely on payday loans<figure><img src="https://images.theconversation.com/files/234286/original/file-20180830-195304-1teuaak.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The spotlight is on Wonga.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com">Ink Drop / Shutterstock.com</a></span></figcaption></figure><p>Wonga, the poster-boy of the British payday lending industry, has <a href="https://www.bbc.co.uk/news/business-45359395">gone into administration</a> following an influx of customer compensation claims. Its demise is a result of government regulation to reform the payday loans sector in favour of the consumer. </p>
<p>A price cap that was introduced by the <a href="https://www.fca.org.uk/firms/price-cap-high-cost-short-term-credit">Financial Conduct Authority (FCA) regulator</a> in 2015 on high-cost, short-term credit means that Wonga and other payday lenders’ history of irresponsible lending is catching up with them. Profits have been eaten into as a result of the cap, with Wonga having to foot the bill for a large <a href="https://www.bbc.co.uk/news/business-45355958">number of compensation claims</a> for loans taken out before the regulation was introduced. It is likely that as a result of the FCA’s ongoing reforms, other high-cost lenders will also collapse.</p>
<p>The experiences of payday loan applicants gives a sense of how significant this is. On the one hand they include people who are in desperate need of credit – often to pay for bills. But, on the other, this leaves them vulnerable to paying a poverty premium.</p>
<h2>Wonga’s rise</h2>
<p>The rise of payday lending came about in the wake of the 2008 financial crash, which brought many households personal financial crises of their own. Household budgets across the board have been squeezed due to rising costs and wage freezes, with many now worse off than <a href="https://www.jrf.org.uk/blog/rising-cost-living-will-hit-low-income-households-hard-2018">before the great recession</a>. </p>
<p>One way to bridge the gap between income and outgoings is by using credit. For many, this means using mainstream bank finance in the form of overdrafts, loans, or credit cards. But a <a href="https://theconversation.com/poor-people-are-penalised-for-borrowing-to-make-ends-meet-a-new-alliance-gives-them-another-way-93464">growing number of households</a> are unable to access mainstream bank finance and are excluded from mainstream options as a result of a low credit score or insecure employment. </p>
<p>High-cost credit in all its different forms (payday loans, home-collected credit, rent-to-buy, log-book loans) operates as an alternative credit market for those excluded from mainstream finance. Payday loans – and Wonga especially – were extremely popular due to the anonymity and ease of applying online and fast access to cash. But huge interest rates led to many paying dearly for this easy access to credit.</p>
<p>The new FCA regulation stopped some of the worst excesses. But, to remain competitive alongside the new regulation, payday lenders changed their operations and innovated new products. For example, some payday loan products have longer repayments terms. This, however, means that the loan is more expensive overall, even though repayments are more affordable. </p>
<h2>People’s experiences</h2>
<p>Alongside Carl Packmam (then at Toynbee Hall and now the <a href="https://www.barrowcadbury.org.uk/what-we-do/fair-design-campaign/">Fair by Design campaign</a> against the poverty premium), I undertook in-depth research with former payday loan takers who then self-identified as “declined applicants” as a result of the regulation. What we found was different to the FCA’s <a href="https://www.fca.org.uk/publication/feedback/fs17-02.pdf">2017 report</a> which said that the majority of former users of payday loans (63%) that have since become a “declined applicant” as a result of the regulation “believe that they are better off as a result”. The FCA’s research indicated that 60% of “declined applicants” do not borrow from other sources and have not turned to other forms of high-cost credit or illegal money lenders.</p>
<p>Our interviews with 80 people who had been declined from a payday loan since the regulation was introduced suggest a more nuanced picture. Talking to people face-to-face, we went more in depth than the FCA’s consumer survey and we found that people took a series of actions. They sought access to other credit after being declined, such as applying to another lender, friends and family. Some tried to avoid borrowing, such as by going without credit or increasing their working hours. </p>
<p>The most common step that people took after being declined was to access money from friends and family. The second was to apply for some other kind of formal credit product. Many of our interviewees were successful in accessing a payday loan from another company after being declined one first. This suggests that some lenders are not adhering to responsible lending or the high-cost, short-term credit regulation and that the “declined applicant” status was temporary for some. Only four people borrowed from an ethical community finance lender (such as credit union or Community Development Finance Institution) and one used a credit card.</p>
<p>This signals to us that more borrowing options were preferable for declined applicants than managing in other ways. Or because the money was needed for essential items such as rent and utilities. This potentially strengthens the case for better and more affordable borrowing options for those now declined a payday loan. </p>
<p>We know credit is not always the solution to all borrower’s problems, but we also know that more affordable credit options would provide a lifeline for many people today who feel their only option is to use very expensive credit products. While the cap on the cost of payday loans has largely had the intended effect of increasing rules around what kind of borrower (and in what kind of situation) can manage using a payday loan with few risks of causing negative financial outcomes, there still needs to be a greater supply of alternative credit products available to fill that demand.</p><img src="https://counter.theconversation.com/content/102419/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lindsey Appleyard receives funding from RCUK, Barrow Cadbury Trust, Carnegie UK Trust and the Money Advice Service</span></em></p>Far too many people in Britain rely on high-cost short-term credit from alternative lenders.Lindsey Appleyard, Research Fellow, Coventry UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/974672018-06-05T13:45:11Z2018-06-05T13:45:11ZPatience with Ramaphosa’s presidency is waning among South Africans<figure><img src="https://images.theconversation.com/files/221584/original/file-20180604-175407-tuldp2.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Patience might be running out for South African President Cyril Ramaphosa.</span> <span class="attribution"><span class="source">GCIS</span></span></figcaption></figure><p>South Africa’s new president, Cyril Ramaphosa, has just crossed <a href="http://www.thepresidency.gov.za/speeches/address-president-cyril-ramaphosa-occasion-presidency-budget-vote-debate%2C-national-assembly">100 days</a> in office with increasing signs that his honeymoon period is already over. The economic realities are hitting home. And the accompanying impatience which seemed suspended since he took over in February is reemerging.</p>
<p>Ramaphosa’s tenure came with renewed hopes about the future of the <a href="https://www.huffingtonpost.co.za/2018/02/21/ramaphosa-takes-charge-of-the-economy_a_23367836/">country’s economy</a>. His state of the nation address, followed by the national budget, <a href="https://mg.co.za/article/2018-02-16-rampahosas-sona-stokes-hope-of-economic-revival">raised optimism</a> that the economy would soon rebound. This followed President Jacob Zuma’s rule which wrecked the economy through a series of <a href="https://www.news24.com/SouthAfrica/News/flashback-5-of-zumas-biggest-scandals-20180213">corruption scandals</a> and <a href="https://www.telegraph.co.uk/news/2017/03/31/south-african-currency-plunges-jacob-zuma-fires-finance-minister/">destructive economic decisions</a>.</p>
<p>Given the depths to which Zuma had taken the country, it was easy for the Ramaphosa euphoria to emerge. A couple of speeches promising a “<a href="http://www.thepresidency.gov.za/speeches/address-president-cyril-ramaphosa-occasion-presidency-budget-vote-debate%2C-national-assembly">new dawn</a>” did the trick. The people ululated and the <a href="https://www.businesslive.co.za/bd/markets/2017-12-19-jse-rallies-to-two-week-high-as-investors-cheer-ramaphosa-victory/">markets cheered</a>.</p>
<p>But it would seem that the honeymoon is over. Patience is waning and giving way to protests against long standing grievances. The failure by the ANC government to deliver basic services and endemic corruption is driving <a href="http://www.ngopulse.org/article/service-delivery-protests-people-need-services">people to the streets</a>.</p>
<p>Many celebrated the decision by one of the top three credit rating agencies to leave South Africa’s rating unchanged. What they missed was it’s long list of warnings. </p>
<p>I believe that this all adds up to the need to be extremely cautious about the country’s immediate future. The real test for Ramaphosa’s presidency is how he will respond to the immediate pressing needs. The people, markets and rating agencies will stand waiting to judge. The latest economic growth figures, showing a <a href="https://www.fin24.com/Economy/South-Africa/sas-first-quarter-gdp-takes-a-knock-shrinks-by-22-20180605">2.2% dip in gross domestic product</a> (GDP) during the first quarter of this year, is not a good sign.</p>
<h2>A closer reading of S&Ps decision</h2>
<p>S&P <a href="https://www.ft.com/content/c9328624-d194-11e7-b781-794ce08b24dc">downgraded South Africa’s</a> sovereign rating to sub-investment grade towards the end of last year, warning that further downgrades were possible. The country’s economy was in a perilous state and faced the possibility of slipping deeper into sub-investment grade. </p>
<p>Against this backdrop, <a href="https://www.fin24.com/Economy/breaking-sp-keeps-sa-sovereign-credit-rating-unchanged-20180525">S&P’s most recent decision</a>, not to downgrade South Africa further, was greeted with delight. But its decision can be interpreted from two perspectives. </p>
<p>On the one hand, the decision was a sign that the rating agency was impressed that the country’s position has not deteriorated further since its last downgrade in November 2017. </p>
<p>The other view is that S&P acknowledged that the country has not done much to improve its fiscal position which remains significantly weak. By keeping the country’s outlook stable, the rating agency is anticipating the economy could improve modestly in the near future if certain reforms are undertaken. But it’s also a warning that should there be deterioration it will be forced to do another downgrade.</p>
<h2>What’s been done, and not done</h2>
<p>Ramaphosa’s government has largely focused on saving key institutions ravaged by the patronage of the Zuma era. This include the <a href="https://www.dailymaverick.co.za/opinionista/2018-05-30-ramaphosa-and-the-dark-side-of-the-dawn/#.WxDbDn34nIU">police and prosecuting agencies</a> and <a href="https://www.timeslive.co.za/news/south-africa/2018-05-31-state-owned-enterprises-are-sewers-of-corruption-ramaphosa/">state-owned enterprises</a>. </p>
<p>There have been <a href="https://www.ujuh.co.za/major-shakeup-at-transnet-eskom-denel-sa-express-list-of-the-new-faces/">big changes</a> in the management of key state-owned enterprises such as the power utility <a href="https://www.businesslive.co.za/fm/fm-fox/2018-02-01-new-management-takes-charge-of-eskom-crisis/">Eskom</a>, regional airline <a href="https://www.iol.co.za/business-report/companies/saa-appoints-turnaround-specialist-bob-head-as-new-cfo-14400380">SA Express</a>, defence company <a href="http://ewn.co.za/2018/04/11/denel-interim-board-gives-staff-management-new-hope">Denel</a> and transport and logistics enterprise <a href="https://www.fin24.com/Companies/Industrial/meet-transnets-six-new-board-members-20180524">Transnet</a>. </p>
<p>This shows that Ramaphosa’s government is committed to rooting out corruption and improving service of these enterprises.</p>
<p>But a number of issues remain problematic. First, the country’s economic growth figures remain subdued and are likely to stay that way for a while. That’s because government is still not showing any firm commitment to undertake structural reforms that are required to jump-start growth. </p>
<p>Secondly, unemployment remains <a href="https://tradingeconomics.com/south-africa/unemployment-rate">significantly high</a> with no practical solution in sight besides a proposed job summit. South Africa’s unemployment stands at 26.7%. The rate is much higher, <a href="https://www.fin24.com/Economy/youth-unemployment-in-sa-a-national-crisis-economists-20170807">around 36%</a>- if disgruntled work seekers are included. Youth unemployment stands at more <a href="https://tradingeconomics.com/south-africa/youth-unemployment-rate">than 52%</a>. Something drastic is required to tackle this problem. Nothing from the prevailing talk fits the bill.</p>
<p>Thirdly, government’s debt burden continues to rise. This is on the back of low growth and a rising social service bill. The bloated civil service and cabinet are not helping the situation. Ramaphosa had a chance to review the cabinet size when he <a href="https://www.news24.com/SouthAfrica/News/ramaphosa-reshuffles-cabinet-20180227">reshuffled</a> it in February but he let it slip presumably for fear of unsettling political support. The continued power balance within the ruling party means that he will shy away from taking hard decisions like rationalising the civil service.</p>
<p>There is also the lingering financial burden posed by state owned enterprises. Besides improvements in their governance, many are run on fundamentally unviable funding models, making it impossible for them to be weaned from government support. </p>
<p>And finally there are the disturbing <a href="https://www.fin24.com/Finweek/Business-and-economy/land-expropriation-farmers-stuck-in-limbo-as-investor-uncertainty-mounts-20180319">uncertainties</a> around the ANC’s move to undertake expropriation of land without compensation. This is undermining the pledge to restore policy certainty and improve economic growth.</p>
<h2>Possible solutions</h2>
<p>Ramaphosa has inherited a ruling party and government faced with a tricky overriding challenge. The ANC is getting increasingly pressured by its voter base to deal with poverty and inequality. And the noise coming from populist groups like the Economic Freedom Fighters (EFF) is piling up the pressure. Arguably, it is this dynamic which led to the adoption of the land expropriation without compensation resolution at the <a href="https://www.cnbcafrica.com/zdnl-mc/2017/12/20/anc-resolutions/">ANC conference</a> in December last year.</p>
<p>And so the government finds itself trying to strike a balance between addressing poverty and inequality while maintaining property rights and ensuring food security.</p>
<p>The main priority of the government should be centred on growing the economy to create jobs and reduce poverty. This could be achieved with structural economic reforms. These could include liberalising the labour market by making changes to the employment laws to lower the costs of hiring and firing workers in order to improve the ability of companies to respond to market shocks.</p>
<p>Economic reforms should include the removal of bottlenecks in the product and service markets to allow establishment and sustenance of small businesses. In addition, the reforms must aim at improving the country’s delicate taxation system through broadening the tax base with targets to reduce social spending in the medium to long-term.</p><img src="https://counter.theconversation.com/content/97467/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Misheck Mutize does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The positive energy that’s greeted the new South African President, Cyril Ramaphosa, will turn to protest if economic challenges are not addressed quickly.Misheck Mutize, Lecturer of Finance and Doctor of Philosophy Candidate, Graduate School of Business (GSB), University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/793362018-02-19T00:45:30Z2018-02-19T00:45:30ZExplainer: what are credit ratings and why do they matter?<p>A new report has <a href="http://asic.gov.au/about-asic/media-centre/find-a-media-release/2018-releases/18-042mr-asic-reports-on-credit-rating-agencies/">highlighted</a> room for improvement in Australian credit ratings agencies, including potential conflicts of interest, overseas staff producing credit ratings, and failures to meet compliance standards. </p>
<p>Having effective credit ratings agencies is vital for Australia, as they assess the creditworthiness of governments, corporations, banks and other entities that wish to raise funds by issuing debt.</p>
<p>The agencies’ decisions can have knock-on effects throughout the economy. The ability of governments to borrow money has an impact on investors and companies, and companies pass on the cost of borrowing to their customers. </p>
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<a href="https://theconversation.com/why-we-should-be-wary-of-ratings-agencies-5482">Why we should be wary of ratings agencies</a>
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<p>Ratings agencies are trying to represent not only the ability of borrowers to repay their loans, but also the willingness to repay on time. </p>
<p>Ratings are given as a ranking. AAA is the highest, then AA and A, right through to C and then D (default).</p>
<p>The lower your credit rating the riskier you are deemed to be and the higher the interest rates charged. Some institutional investors (such as pension funds) are not allowed to hold debt with a credit rating of BB or below.</p>
<p>The exact methodology used by the ratings agencies is not publicly released. But ratings are based on a mix of public information and private information provided by the debt issuers.</p>
<p>When it comes to giving the federal government a rating, agencies will use publicly available economic data such as economic growth, income per capita and unemployment and inflation rates. This gives the agency an idea of the current state of the economy, as well as where it might be in the short and long term. </p>
<p>Agencies will also look at the federal government’s budget. They will consider the gap between revenues and expenditures, when the government’s debts are due, and the quality of assets that the government could sell off.</p>
<p>Lastly, the agency will look at the wider economic and political context. This includes the quality of financial regulators and levels of corruption and political stability. It also includes potential internal or external vulnerabilities, such as an economic slowdown in China or the possibility of a trade war. </p>
<p>All of these factors have an impact on the ability and willingness to repay debt, even if they are beyond the government’s control. </p>
<p>Similar considerations are applied to the credit ratings of banks and other large corporations. But the agency would also consider how likely it is that the government would bail out the company in a crisis. There is <a href="http://fsi.gov.au/files/2014/12/FSI_Final_Report_Consolidated20141210.pdf">a perception</a>, for example, that the government would bail out the big four banks.</p>
<h2>The impact of credit ratings</h2>
<p>Last year S&P put Australia on a “<a href="https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1882241&SctArtId=431333&from=CM&nsl_code=LIME&sourceObjectId=10163378&sourceRevId=3&fee_ind=N&exp_date=20270713-21:07:43">negative outlook</a>”, meaning the federal government’s AAA credit rating could be downgraded. </p>
<p>The immediate impact of a credit rating downgrade is that the interest rates paid by the federal government will go up. But <a href="http://isiarticles.com/bundles/Article/pre/pdf/23556.pdf">research shows</a> that a federal government ratings downgrade has wide-ranging impacts.</p>
<p>The credit ratings of both banks and many corporations are tied to the federal government’s. This means a federal government downgrade will have impacts on many companies, investors and individual borrowers.</p>
<p>Share markets would be affected, but so would other borrowers, including foreign governments. </p>
<p>Further, the credit assessments of governments and banks are <a href="http://onlinelibrary.wiley.com/doi/10.1111/jofi.12206/abstract">often intertwined</a>, especially in times of financial crises.</p>
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<a href="https://theconversation.com/australia-could-be-about-to-lose-its-aaa-rating-and-heres-why-62039">Australia could be about to lose its AAA rating, and here's why</a>
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<p>The link between governments and banks can create a negative feedback loop. A downgrade for either banks or governments increases bank borrowing costs. This makes it more likely banks will need to be bailed out by the government in the near future. This puts more pressure on the government’s finances, which could lead to another government credit rating downgrade. </p>
<p>But a downgrade doesn’t affect only banks. Recent <a href="http://onlinelibrary.wiley.com/doi/10.1111/jofi.12434/full">research</a> shows that when a government’s credit rating is downgraded, companies with similar credit ratings also see a ratings change, even if there is no fundamental change in their own creditworthiness. </p>
<p>Again, there is a negative feedback loop. A government credit rating downgrade leads to downgrades for corporations. The corporations, faced with increased borrowing costs, will respond by cutting back on new investments, which slows down the real economy. The slowdown in the economy will put more pressure on the government’s credit rating.</p>
<p>And on top of all that, when banks face higher borrowing costs, they either pass this on to households and investors in the form of higher lending rates and/or cut back on their <a href="https://academic.oup.com/rfs/article-abstract/29/7/1709/2607032/Bank-Ratings-and-Lending-Supply-Evidence-from?redirectedFrom=fulltext">lending</a>. </p>
<p>This, of course, also has the effect of slowing down the economy, creating a double whammy.</p>
<p>So you can see that ratings agencies play an important role in the economy. </p>
<p>The Australian Securities and Investment Commission has made a number of <a href="http://asic.gov.au/about-asic/media-centre/find-a-media-release/2018-releases/18-042mr-asic-reports-on-credit-rating-agencies/">recommendations</a> to improve governance within credit ratings agencies, to make them more informative and reliable. Adopting these will go a long way to further restore market confidence in the ratings agencies and improve investor protection.</p><img src="https://counter.theconversation.com/content/79336/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Eliza Wu receives funding from the Australian Research Council. </span></em></p>Robust credit ratings agencies are vital for the Australian economy, as the repercussions of their decisions are felt far and wide.Eliza Wu, Associate Professor in Finance, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/916882018-02-14T16:27:14Z2018-02-14T16:27:14ZThe real reason why cities in sub-Saharan Africa aren’t issuing municipal bonds<figure><img src="https://images.theconversation.com/files/206241/original/file-20180213-118385-nj5yaq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">REUTERS/Euroluftbild.de</span></span></figcaption></figure><p>Cities around the world have been financing their long-term investment needs through municipal bonds for centuries. The first recorded transaction occurred in Genoa in 1150. More recently, in the US, over <a href="https://www.ft.com/content/b792c166-fc61-11e7-9b32-d7d59aace167">USD$111 billion</a> were issued in November and December last year for infrastructure, pension obligations and other critical needs across the country.</p>
<p>A bond is a debt security issued by a public agency to raise money, often for infrastructure projects. Sovereign bonds are widely used by national governments, and municipal bonds are used by many cities (particularly in the Americas). </p>
<p>For comparison, cities in sub-Saharan Africa have raised less than 1% of the US amount since 2004. Only a handful of local governments have successfully issued municipal bonds, almost all of them in South Africa. Yet there is a desperate need for infrastructure investment throughout the region. Current estimates place the financing gap at <a href="http://www.imf.org/external/pubs/ft/fandd/2016/06/sy.htm">USD$ 41.6 billion</a>. Municipal bonds, originated for urban infrastructure, will go a long way to addressing this gap.
Why aren’t African cities using municipal bonds to raise money for capital projects?</p>
<p>Some international experts point to a lack of local capacity and technical ability to prepare a municipal bond. Others argue that projects are not structured in ways that ensure a sufficient return to prospective investors. Still another group insists that municipal leaders lack the interest or ability to use more transparent financing instruments.</p>
<p>All of these views stem from a belief that civil servants and investors in sub-Saharan Africa are not exposed to global financial best practices, or are unwilling to comply with them. Some of these assumptions are both wrong and offensive.</p>
<p>My <a href="http://journals.sagepub.com/doi/full/10.1177/0956247817741853">paper</a> considered this question and came to a conclusion that there is another key contributing factor that is often overlooked. This is the weakness in regulations governing the roles and powers of cities’ authorities to raise finance and the ability of central governments to adjust these based on political whims.</p>
<p>This creates an uncertain environment. Prospective issuers cannot be confident that their preparatory work will ultimately lead to a transaction. And they can’t be sure that their efforts can be undone at the last minute by a government.</p>
<h2>A bridge too far for Dakar?</h2>
<p>In my paper I argue that poor financial skills and ignorance is less of a problem than many suggest. </p>
<p>Take, for example, the cities of Dakar (Senegal) and Kampala (Uganda). Both recognised the need to reduce their reliance on development assistance or commercial banks. They also recognised that, to attract investment from institutional investors like pension funds and insurance companies, they would have to demonstrate their creditworthiness.</p>
<p>Creditworthiness can be understood as both the willingness and the ability to borrow. To achieve a satisfactory credit rating, Kampala and Dakar needed to prove that they could reliably raise and manage money from a range of local sources, including from property taxes, parking fines and license fees.</p>
<p>Months of dedicated work yielded positive results. Independent ratings agencies assessed the health of the cities’ finance systems. Both cities received investment-grade credit ratings, meaning that prospective investors could be reasonably confident of recovering their money.</p>
<p>Indeed, after the cities secured these credit ratings, several local investors indicated their desire to purchase municipal bonds. </p>
<p>But political conflicts between the local and national levels led to Dakar’s bond issuance being <a href="http://citiscope.org/story/2015/how-dakar-almost-got-its-first-municipal-bond-market">cancelled</a> at the last minute. And in the case of Kampala, national regulation has <a href="http://newclimateeconomy.report/workingpapers/workingpaper/financing-the-urban-transition-policymakers-summary/">capped</a> the city’s borrowing at a prohibitively low amount. This limit means that the city cannot borrow enough money to make bond issuance worthwhile. </p>
<h2>What’s the real problem?</h2>
<p>If the issue doesn’t stem from creditworthiness, technical proficiency, or financial market readiness, there must be another factor limiting municipal bond issuance.</p>
<p>My <a href="http://journals.sagepub.com/doi/full/10.1177/0956247817741853">paper</a> attributes the lack of bond issuance not to the municipality or potential investors, but to limiting behaviour of national governments. </p>
<p>While they devolve substantial responsibilities to cities, they limit their ability to raise funds. This is often driven by a fear on the part of sovereign leadership to allow cities to have a hand in holding their own purse strings. This power can ultimately lead to less dependence on the national government.</p>
<p>A closer look at a number of cities shows that only those in highly centralised countries – like Cameroon – or highly decentralised countries – like South Africa – have been able to successfully issue bonds. The argument for the success of bond issuance in decentralised economies is well-understood in the African context and more broadly around the world. But the case for success in countries at the other end of the spectrum is less-considered but equally valid.</p>
<p>Cities in heavily centralised countries are not provided with autonomy for decision-making. Instead they are positioned as direct participants within an administrative machine governed by decisions from the capital. Any financial obligation entered into by a city in this political ecosystem is viewed as one explicitly guaranteed by the central government.</p>
<p>South Africa provides a good example of how enabling legislation can help municipalities raise money. In 2004 the country passed a law – <a href="https://www.acts.co.za/municipal-finance-management-act-2003/index.html">The Municipal Finance Management Act</a> – that sets out clearly what financial activities cities can and can’t undertake. Cities are prohibited from borrowing for operational expenditures and, instead, can only borrow for long-term investments.</p>
<p>The law has made it safer for pension funds, insurance companies and other investors to lend to city governments. They know that municipalities cannot issue bonds without being in full compliance with existing regulations that are not subject to different types of interpretation or changes in political will.</p>
<p>By comparison, the cities of Dakar and Kampala have struggled because of ambiguous or contested relationships with their national governments. And both cities have spent years improving their revenue collection and management systems to achieve an investment-grade credit rating. Yet the constraints on municipal bonds are created by systems beyond the city’s control.</p>
<h2>Clarity is key</h2>
<p>More African governments need to clarify enabling regulatory and legal environments on the sub-national level. These must explain how much cities can borrow and under what conditions. Only then will African cities be able to use bonds to finance the infrastructure their citizens so desperately need.</p><img src="https://counter.theconversation.com/content/91688/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jeremy Gorelick does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>African cities are failing to raise development funds through bond markets.Jeremy Gorelick, Lecturer in Emerging Markets Finance, Johns Hopkins UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/899822018-01-15T15:13:28Z2018-01-15T15:13:28ZWhy Zuma’s free higher education plan will cripple South Africa’s finances<figure><img src="https://images.theconversation.com/files/201914/original/file-20180115-101511-dh2sjn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">REUTERS/Siphiwe Sibeko</span></span></figcaption></figure><p>South Africa’s fee-free higher education initiative, controversially introduced by President Jacob Zuma in the dying weeks of 2017, will plunge the country into a deeper financial crisis if it isn’t <a href="https://www.dailymaverick.co.za/article/2017-12-18-analysis-what-cost-the-presidents-free-tertiary-education-plan/#.WliVTa6WbIU">adjusted one way or another</a>. </p>
<p>Days after Zuma made his surprise announcement, Ramaphosa was elected president of South Africa’s ruling party, the African National Congress. He is set to become the country’s president when Zuma’s term expires if the ANC wins the country’s <a href="http://beta.latimes.com/world/africa/la-fg-south-africa-ramaphosa-20171219-story.html">2019 national elections</a>.</p>
<p>It’s now for Zuma’s successor Ramaphosa to do the tricky tampering. He will need to be politically and financially adept to manage this situation. He can’t simply reverse a populist decision and he clearly won’t be able to meet it fully without serious adjustments to the country’s finances. </p>
<p>Zuma’s plan seeks to provide fee-free tertiary education to students from households with a combined annual income of less than R350,000 with immediate effect. Estimations suggest that this covers 90% of students in the <a href="https://www.iol.co.za/news/politics/read-zumas-fees-announcement-here-12441467">higher education system</a>.</p>
<p>This is certainly a noble idea. But Zuma’s rushed unilateral decision ignored all sensible views that it can’t be done in the way he is proposing. Zuma ignored the <a href="https://businesstech.co.za/news/finance/210415/treasury-tried-to-stop-zumas-free-education-plan-report/">National Treasury</a> headed by Finance Minister Malusi Gigaba, whom he handpicked. And he disregarded the views of <a href="https://www.moneyweb.co.za/news/how-zuma-defied-national-treasury-and-heher-inquiry-in-announcing-free-higher-education/">the Heher Commission</a> he appointed to look into the matter, which stated emphatically that South Africa cannot afford fee free education.</p>
<p>The cost of this proposal could be disastrous for a country that’s already burdened by significant <a href="https://www.moneyweb.co.za/in-depth/budget/ratings-downgrades-loom-as-sas-debt-burden-mounts/">debt</a> considering that Zuma’s promise will cost the country between R15 billion and R50 billion per year. At current debt levels, South Africa’s public finances are already highly constrained. The country is struggling to fill the R50.8 billion budget deficit, which is projected to rise to R89.4 billion by 2020. This is approximately -4.75% of GDP, the <a href="https://tradingeconomics.com/south-africa/government-budget">highest since 2009</a> and more than the average of -3.26% over the period from <a href="https://www.cia.gov/library/publications/the-world-factbook/geos/sf.html">1989 to 2017</a>.</p>
<h2>The sovereign debt situation</h2>
<p>Since the dawn of democracy, South Africa has become more reliant on sovereign bond issuance to support its budget. South Africa’s sovereign bonds are issued by the government through the South African Reserve Bank primarily to raise funds for large capital projects. </p>
<p>The government’s debt has been rising steadily for the last decade. It reached a record high of R790 billion (51% of GDP) in the second quarter of 2017, up from R726 billion in the first quarter of 2017. It is expected to rise even further, with some estimates suggesting it will shoot up to more than R2 trillion (60% of GDP) by 2020. This is far higher than the average R390 billion from 2002 until 2017. </p>
<p>At this debt level, the government is paying approximately <a href="https://cnx.org/contents/kQuPiYcX@1/Government-Spending">R13 of every R100 (13%)</a> collected in revenue as interest payments to sovereign lenders. This figure is much higher than expenditure in general public services (5.5%), defence and security (4.8%), police services and (6.7%), basic education (7.3%), tertiary education (9.2%), and economic infrastructure (6.8%). </p>
<p>The government debt servicing costs for 2018 are estimated at R183 billion, which is forecasted to rise to R223 billion by 2021. This means government debt repayment is the fastest growing expenditure item of the budget. The implication is that in the next three years the government will be spending more money on repaying its debts than on key service delivery priorities such as social and economic development. </p>
<p>It’s therefore clear that the country can’t afford to add another R15 billion to R50 billion to expenditure. </p>
<h2>Available options</h2>
<p>Funding for Zuma’s fee-free plan will either have to come from tax hikes (including an increase in the Value Added Tax rate), significant austerity, budget reallocation’s or additional borrowing. </p>
<p>With an economy stuck at sub-optimal growth, facing more rating downgrades, and a significant tax shortfall in the near future, the Ramaphosa administration may face the political inconvenience of having to explain why Zuma’s education announcement has to be retracted, amended, or delayed.</p>
<p>Retracting or delaying the policy aren’t options because either would likely spark civil unrest. But populist policies such as these condone financial indiscipline at the expense of much needed fiscal consolidation. The consequences will be severely damaging to the country’s development for many years. </p>
<p>It is vital that the government tackles the escalating sovereign debt by drawing up a proper implementation strategy. This needs to be in line with austerity measures to allow fiscal consolidation to reduce the widening budget deficit.</p>
<p>It must do this in a way by balancing three things: economic growth, a smaller fiscal deficit and meeting increasing social demands. Instead of trying to raise funding for free higher education the government should rather consider disposing unessential state assets, reducing government debt guarantees to state owned companies, and clamping down on corruption and wasteful expenditure. </p>
<h2>Fiscal cliff</h2>
<p>If the fiscal situation continues to deteriorate, South Africa risks having its domestic bond ratings downgraded to sub-investment grade by all the three international credit rating agencies. This would be disastrous for the country, which has already been subject to downgrades on its foreign denominated debt. </p>
<p>Moody’s is the only international rating agency that hasn’t downgraded South Africa to “junk status”. If it does so to the country’s sovereign currency rating, the country’s sovereign bonds would be excluded from the Citigroup’s world government bond index. If this happens many foreign asset managers with investment grade mandates would dump the country’s domestic bonds. South Africa’s bond yields will shoot up, further escalating debt servicing costs. Similar circumstances have led countries such as Brazil, Cyprus, and Greece into <a href="https://www.forbes.com/sites/kenrapoza/2017/05/19/safe-for-now-brazil-credit-rating-holds-amidst-crisis/#33c1779b1abc">vicious debt cycles</a>. </p>
<p>Zuma may have lobbed a populist hot potato at the ANC elective conference. But it’s ordinary South Africans whose fingers will be burnt.</p><img src="https://counter.theconversation.com/content/89982/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sean Gossel receives funding from the University of Cape Town. </span></em></p><p class="fine-print"><em><span>Misheck Mutize does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In announcing free higher education, South African President Jacob Zuma, lobbed a populist hot potato at the ANC elective conference but it’s ordinary people whose fingers will be burnt.Sean Gossel, Senior Lecturer, UCT Graduate School of Business, University of Cape TownMisheck Mutize, Lecturer of Finance and Doctor of Philosophy Candidate, Graduate School of Business (GSB), University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/883482018-01-15T11:35:12Z2018-01-15T11:35:12ZChina’s dystopian social credit system is a harbinger of the global age of the algorithm<p>The Chinese government’s ongoing attempts to create a social credit system aimed at rating the trustworthiness of people and companies have generated equal measures of fascination and anxiety around the world. Social credit is depicted as something uniquely Chinese – a <a href="https://www.economist.com/news/leaders/21711904-worrying-experiments-new-form-social-control-chinas-digital-dictatorship">nefarious</a> and perverse digital innovation that could only be conceived of and carried out by a regime like the Chinese Communist Party. </p>
<p>The proposed system will draw on data gathered from individuals and businesses to provide social credit scores based on both economic and social behaviour. While government proposals provide little detail about how scores will be calculated, current pilots use both online <a href="https://cpianalysis.org/2017/12/04/contextualizing-chinas-online-credit-rating-system/">consumer behaviour and the scores of others</a> in a person’s network.</p>
<p>The <a href="http://www.gov.cn/zhengce/content/2016-12/30/content_5154830.htm">stated aim</a> is to “provide the trustworthy with benefits and discipline the untrustworthy … [so that] integrity becomes a widespread social value”. The official documents are light on detail, but have suggested various ways <a href="http://press-files.anu.edu.au/downloads/press/n2543/pdf/ch06_forum_loubere.pdf">to punish</a> untrustworthy members of society with low scores, such as through restrictions on employment, consumption, travel, and access to credit.</p>
<p>It is seen as a signal of a dystopian future, but one that could only exist in China’s authoritarian context. But China’s plans to “build an environment of trust” – as the Chinese government’s State Council <a href="https://www.google.com/url?q=http://www.gov.cn/zhengce/content/2016-12/30/content_5154830.htm&sa=D&ust=1513869721474000&usg=AFQjCNEPR8ROLRcO4BkN2vGa9olilA1Low">puts it</a> – using the data generated from digital activity is not uniquely Chinese. And the country’s experiments are a natural extension of a global trend where data is being used to control society.</p>
<h2>Pilots underway</h2>
<p>The impetus to create a social credit system in China came largely from the country’s dearth of a credit rating infrastructure; most people have <a href="https://cpianalysis.org/2017/12/04/contextualizing-chinas-online-credit-rating-system/">no credit score</a>. In 2014 the government <a href="https://chinacopyrightandmedia.wordpress.com/2014/06/14/planning-outline-for-the-construction-of-a-social-credit-system-2014-2020/">outlined plans</a> to create a nationwide social credit system by 2020. </p>
<p>Today, the Chinese social credit system is far from unified or centralised. Like most new policies in China, it is being subjected to China’s distinctive <a href="http://www.journals.uchicago.edu/doi/abs/10.1086/tcj.59.20066378?journalCode=tcj&">policy modelling process</a>. Local governments produce their own interpretations of policies, which then vie to become national models. Currently, over 30 local governments have been piloting social credit systems, using different approaches to arrive at their social credit scores.</p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"816839913945595904"}"></div></p>
<p>In contrast to other policies, however, <a href="https://www.ft.com/content/f772a9ce-60c4-11e7-91a7-502f7ee26895">until recently</a> social credit was also being piloted by eight large Chinese internet companies. The most well-known of these is Alibaba’s <a href="https://www.cnbc.com/2017/03/16/china-social-credit-system-ant-financials-sesame-credit-and-others-give-scores-that-go-beyond-fico.html">Sesame Credit</a>, which uses opaque algorithms to arrive at social credit scores for their customers drawn from data provided by an affiliate company called Ant Financial. Those with high scores – the top score is 950 – have been able to access <a href="https://cpianalysis.org/2017/12/04/contextualizing-chinas-online-credit-rating-system/">a range of benefits</a> from other Alibaba businesses and their partners. In mid-2017 the government <a href="https://www.ft.com/content/f772a9ce-60c4-11e7-91a7-502f7ee26895">declined to renew</a> the licenses for the private pilots over conflict of interest concerns. However, the door has been left open for these pilots to be merged into the ongoing attempts to construct a nationwide government-run system.</p>
<p>The expansion of these social credit systems fits neatly into moral and economic narratives that are now prominent in China. These are linked to <a href="https://theconversation.com/chinas-plan-to-put-two-faced-citizens-on-credit-blacklist-isnt-all-that-foreign-51102">a percieved</a> “trust deficit” in the country. High profile cases of economic and social fraud regularly go viral on Chinese social media. This has resulted in a popular discourse of the decline of morality and the inability to trust other people or companies. </p>
<p>Social credit is also presented as a way to improve financial inclusion. Supporters argue that expanding financial services and credit to previously excluded groups is good for socioeconomic development. They believe intrusive methods of assessing creditworthiness <a href="https://chinadigitaltimes.net/2017/02/qa-shazeda-ahmed-on-chinas-social-credit-system/">are justified</a> in order to reduce the risk to lenders. In this way, Chinese social credit mirrors financial inclusion initiatives elsewhere, such as the use of <a href="https://www.economist.com/news/finance-and-economics/21707978-how-personality-testing-could-help-financial-inclusion-testscharacter">psychometrics and other personal digital data</a> to determine whether someone is eligible for a loan.</p>
<h2>Social credit beyond China</h2>
<p>Socio-economic credit systems are not confined to China. Most industrialised nations have relied on credit ratings for decades to quantify the financial risks associated with countries, firms, and <a href="https://link.springer.com/article/10.1186/s40854-015-0005-6">individuals</a>. But social factors are increasingly being included to make more accurate predictions. </p>
<p>In China, Alibaba’s Sesame Credit <a href="https://www.wired.com/story/age-of-social-credit/">factors in credit scores</a> of a debtor’s social network. This means that those with low-score contacts will see a negative impact on their own scores. In the US, Affirm, a San Francisco-based lender headed by PayPal co-founder Max Levchin, combs through a wide range of sources, such as social networks, to <a href="http://fortune.com/2015/12/01/tech-loans-credit-affirm-zest/">evaluate the default risk of a creditor</a>. And Lenddo, a Hong Kong-based company, took an even bolder approach and <a href="http://knowledge.wharton.upenn.edu/article/the-social-credit-score-separating-the-data-from-the-noise/">informed debtors’ friends on Facebook</a> when they didn’t pay instalments in time.</p>
<p>So, credit scores based on social action aren’t just unique to China and authoritarian regimes. However, this doesn’t make them less concerning. </p>
<p>The primary downside of public rating systems like social credit is the far-reaching consequences of low ratings. In China, a recent administrative regulation dictates that defaulting debtors will be listed and shamed on <a href="https://www.forbes.com/sites/sarahsu/2017/10/12/debtors-exposed-in-china-as-social-credit-system-unfolds/#6712f41e45c5">online platforms</a>. Similar measures have taken place in the US. The New York Post, for instance, filed a Freedom of Information request and published the performance ratings and names of teachers evaluated by a <a href="https://www.ted.com/talks/cathy_o_neil_the_era_of_blind_faith_in_big_data_must_end/transcript">“secret algorithm”</a> in an attempt to shame those deemed not to be performing as well.</p>
<h2>Rule by algorithms</h2>
<p>Experiments repeatedly confirm that data and algorithms are as biased as society is and reproduce real life segmentation and <a href="http://www.telegraph.co.uk/news/2017/08/24/ai-robots-sexist-racist-experts-warn/">inequality</a>. In her book the <a href="http://www.telegraph.co.uk/news/2017/08/24/ai-robots-sexist-racist-experts-warn/">Weapons of Math Destruction</a>, American mathematician Cathy O’Neil warned that we need algorithmic <a href="https://www.ted.com/talks/cathy_o_neil_the_era_of_blind_faith_in_big_data_must_end/transcript">audits</a>. </p>
<p>Algorithms that measure social credit and trustworthiness could theoretically be fair – but those in positions of power may well find a way to circumnavigate them. And even though social credit schemes are supposed to extend access to financial resources to previously excluded populations, it’s likely that credit solutions driven by big data will exacerbate existing social divides. In the US, for example, 45m Americans do not have a credit score because they lack a credit history and minority groups and low-income neighbourhoods have a disproportionately <a href="https://www.cnbc.com/2015/05/05/credit-invisible-26-million-have-no-credit-score.html">high rate of credit invisibility</a>. For China, it’s <a href="https://chinadigitaltimes.net/2017/02/qa-shazeda-ahmed-on-chinas-social-credit-system/">likely</a> something similar could emerge.</p>
<p>Social credit has the potential to cement and exacerbate existent power imbalances in societies, while simultaneously closing down spaces of resistance. The social credit system in development in China is a phenomenon that belongs to a global trend with a transformative potential that is just as threatening in Western democracies. It is but one harbinger of a likely common digital future marked by a shift away from the rule of law and towards rule by algorithms.</p><img src="https://counter.theconversation.com/content/88348/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stefan Brehm receives funding from the Swedish Research Council for a research project on "Digital China". </span></em></p><p class="fine-print"><em><span>Nicholas Loubere does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Plans for China to rate its citizens for their trustworthiness have been depicted as uniquely Chinese. Don’t be so sure.Stefan Brehm, Researcher, Lund UniversityNicholas Loubere, Associate Senior Lecturer in the Study of Modern China, Lund UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/867572017-11-03T00:00:26Z2017-11-03T00:00:26ZForcing the banks to hand over our credit history might help with a home loan but it has risks<p>The <a href="http://sjm.ministers.treasury.gov.au/media-release/110-2017/">federal government will be forcing banks</a> to hand over half their credit data ready for reporting by mid-2018 (with the remainder available in 2019). </p>
<p>It seems rather quaint in the age of big data that the big four banks have been able to hold onto their treasure troves of loan data for so long. This data reveals how reliable we are at repaying our loans. This information is gold to a lender. </p>
<p>For the government’s proposed legislation to work well, it would need to ensure effective regulatory systems are in place to protect our data and avoid more mortgage stress. To achieve this, lessons need to be learned from the US experience.</p>
<p>The new legislation on credit data promises to open up the consumer credit market to increased competition. This may in turn lead to cheaper loans. </p>
<p>Nimble competitors using new technologies could offer consumers innovative loan products at competitive interest rates. Non-traditional lenders could aggressively expand their market share at the expense of the banks. Consumers would seem to be the beneficiaries.</p>
<h2>Lessons from the global financial crisis</h2>
<p>Australia has long maintained one of the most restrictive <a href="https://books.google.com.au/books?hl=en&lr=&id=if2xjLv74HYC&oi=fnd&pg=PA273&dq=J+Barron+and+M+Staten+%E2%80%98The+Value+of+Comprehensive+Credit+Report:+Lessons+from+the+US+Experience%E2%80%99+in+Credit+Reporting+Systems+and+the+International+Economy+(MIT+Press,+Cambridge+Mass,+2003)+&ots=uD2_nMsTmX&sig=NcDHHieq7GRoeLAbY_lYdMrYmcI#v=onepage&q&f=false">credit reporting systems amongst OECD countries</a>. Australia’s reporting system had only allowed credit reporting agencies such as Equifax and Dun and Bradstreet to report on consumers’ bad credit histories. These histories include things such as bankruptcies, and late loan and rental repayments. </p>
<p>The US system already has required reporting of the positive aspects of a consumer’s credit behaviour, including their timely loan repayments. This has enabled companies to develop statistical scoring models to estimate a consumer’s loan default risk with remarkable accuracy. Credit scoring became the cornerstone for underwriting <a href="https://books.google.com.au/books?hl=en&lr=&id=if2xjLv74HYC&oi=fnd&pg=PA273&dq=J+Barron+and+M+Staten+%E2%80%98The+Value+of+Comprehensive+Credit+Report:+Lessons+from+the+US+Experience%E2%80%99+in+Credit+Reporting+Systems+and+the+International+Economy+(MIT+Press,+Cambridge+Mass,+2003)+&ots=uD2_nMsTmX&sig=NcDHHieq7GRoeLAbY_lYdMrYmcI#v=onepage&q&f=false">decisions for consumer loans</a>.</p>
<p>Unsurprisingly, this led to intense competition. With more accurate data, lenders no longer had to assume that low income consumers represented a higher risk of defaulting on their loans. </p>
<p>With customer loan histories being made available to competitors, low income consumers with a history of being reliable repayers were offered loans. As competition intensified, an ever-expanding <a href="http://www.emeraldinsight.com/doi/abs/10.1108/S0733-558X%282010%29000030A008">sub-prime loan mortgage market developed</a>. Shoddy loan practices became rife, setting the stage for the 2008 global financial crisis.</p>
<p>Australian households overall are <a href="https://www.imf.org/en/Publications/GFSR/Issues/2017/09/27/global-financial-stability-report-october-2017">already heavily in debt</a>. Intense competition resulting from the proposed new legislation risks pushing households deeper into debt. Low income consumers risk becoming more vulnerable to falling into debt traps. </p>
<p>Partly in response to the global financial crisis, Australia introduced responsible lending obligations on lenders, which are designed to stop loans to consumers who lack the capacity to repay them. However, the US subprime experience showed that lenders became adept at dodging the rules, and regulators <a href="https://global.oup.com/academic/product/the-subprime-virus-9780195388824?cc=au&lang=en&">appeared to lack the will to enforce them</a>. The regulators will need to be particularly vigilant to avoid this occurring in Australia. </p>
<p>Compelling the big banks to release loan histories to third parties, such as credit reporting agencies, raises further risks that need to be closely attended to. Lenders will either create their own credit scoring models from the data provided by the banks, or rely on the scores produced by credit reporting agencies. </p>
<p>A bad or inaccurate score will have serious implications for a consumer. They may either be refused loans, or only be offered interest rates that are higher than if their score had been accurate.</p>
<p>There needs to be effective systems in place to ensure consumers have ready access to their score, and that they be able to challenge any inaccuracies. Informational transparency should apply for the benefit of both lenders and consumers.</p>
<p>Yet another risk is that our personal loan information will be stolen by criminals. Earlier this year, credit rating agency Equifax was subjected to a cyber attack affecting <a href="https://www.theguardian.com/technology/2017/oct/11/personal-details-of-almost-700000-britons-hacked-in-cyber-attack">over 143 million Americans and over 600,000 Brits</a>. Australia’s largest credit reporting agency, Equifax Pty Ltd, is a wholly owned subsidiary of Equifax Inc.</p>
<p>The data breach is subjecting US and UK consumers to increased risks of identity fraud and targeted scams. Requiring the banks to release our loan data to third parties increases the risk of data breaches. </p>
<p>Increased competition can offer considerable benefits for consumers. However, overheated competition risks damaging the interests of individual consumers, and the economy as a whole. </p>
<p>Consumers also face the increased likelihood of data breaches. The federal government and its regulatory agencies will need to be highly alert to these dangers, and ever vigilant.</p><img src="https://counter.theconversation.com/content/86757/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Justin Malbon consults to Comminsure, which is presently owned by the Commonwealth Bank. </span></em></p>The government needs to learn from the mistakes in the US in sharing our credit history information to third parties.Justin Malbon, Professor of Law, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/863622017-10-25T17:13:52Z2017-10-25T17:13:52ZLatest budget underscores desperate state of South Africa’s finances<figure><img src="https://images.theconversation.com/files/191868/original/file-20171025-25544-mk8ea5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Running out of options. Finance Minister Malusi Gigaba speaks after delivering his medium term budget.</span> <span class="attribution"><span class="source">REUTERS/Sumaya Hisham</span></span></figcaption></figure><p>South Africa’s 2017 medium-term budget policy <a href="http://www.treasury.gov.za/documents/MTBPS/2017/">statement</a> represents a watershed moment in the post-apartheid economic and fiscal position. The best thing that can be said about it, is that it was at least frankly honest about the situation the country is facing. Arguably, there was no choice. The country has reached a situation where it’s no longer possible to spin the notion that public debt is under control.</p>
<p>In <a href="http://www.treasury.gov.za/documents/MTBPS/2016/default.aspx">recent years</a>, South Africa’s National Treasury has desperately, and creatively, tried to avoid making deep cuts to government expenditure, or imposing drastic revenue raising measures on citizens. It did this while still convincing investors and credit ratings agencies that public finances would stabilise.</p>
<p>But the 2017 medium term budget makes it clear that the project has essentially reached the end of the road. The notion that national debt will stabilise has now effectively had to be abandoned. South Africa’s latest finance minister, Malusi Gigaba, effectively gave up on the debt targets set out by Pravin Gordhan a year ago when he stated that net national debt as a percent of GDP should stabilise at 47.9% by 2019/20. Gigaba announced yesterday that this is expected to be 49.1% by the end of this fiscal year, increasing to 53.9% by 2019/20. </p>
<p>This is a clear sign that any attempt to stabilise debt has failed. A further ratings downgrade is now highly likely. And it will be worse than the last one which only affected foreign currency debt. Gigaba’s budget proposals are likely to lead to a downgrade of the country’s local denominated debt, which will increase government borrowing costs and could lead to significant capital outflows. Even without a downgrade the medium term budget reveals that debt service costs are expected to increase from 11% of total expenditure to 15% over the next few years.</p>
<p>Without higher revenue, that means less money to spend on government’s constitutional obligations and policy commitments. Unfortunately, the gloomy story is largely driven by a massive shortfall in revenue collection of R50.8 billion. So attempting to avoid these consequences through taxation is not looking like a feasible option. </p>
<p>In the current political environment, even the best case scenario is grim. In fact the country’s finances could worsen even further if the outcome of the governing party’s elective conference in December doesn’t see a return to good governance and responsible fiscal management.</p>
<h2>Slippery slope since 2008</h2>
<p>In the years since the global <a href="https://www.economist.com/news/schoolsbrief/21584534-effects-financial-crisis-are-still-being-felt-five-years-article">financial crisis</a> that started in 2008, the government allowed expenditure to increase faster than growth and revenue. This was done with the hope of offsetting the short-term effects of the crisis and getting the country back onto a stable path of significant economic growth. </p>
<p>That led to a rapid increase in national debt relative to the size of the economy. But the failure of the economy to recover – due in part to political instability, bad decision making and poor governance – meant that this approach became unsustainable. </p>
<p>In the last few years successive national budgets have walked a tightrope in trying to contain the growth in debt. Planned spending has been reduced, while some tax rates have been increased and new tax instruments introduced. Amid all these manoeuvres, dramatic cuts to government expenditure, or wide-reaching increases in taxes, have been avoided. </p>
<p>Efforts to arrest fiscal decline were sabotaged by the <a href="https://theconversation.com/south-africas-jacob-zuma-is-fast-running-out-of-political-lives-80009">removal</a> of Gordhan in March this year. His removal meant that the institutional reputation of the finance ministry was compromised and, since it was this that had kept the country’s credit ratings intact despite increasing fiscal pressure, the country’s foreign denominated debt was <a href="https://theconversation.com/what-a-downgrade-means-for-south-africa-and-what-it-can-do-about-it-75704">downgraded</a> to “junk” (sub-investment grade).</p>
<h2>Storm clouds on the horizon</h2>
<p>As if the picture wasn’t gloomy enough, numerous risks to the fiscal projections and proposals loom on the horizon. South Africa’s president Jacob Zuma continues to sit on the higher education funding report, causing further instability at universities. That leaves open the possibility that more money for university students may be needed at short notice. </p>
<p>And the finances of various state owned enterprises are teetering, requiring increasing government support to prop them up. Since Gigaba took over the ministry he has taken R5.2 billion from the R6 billion “contingency reserve” – which is meant to be used for emergencies, or other unforeseeable events, such as natural disasters – to prop-up South African Airways. This broke with commitments to fund bailouts using revenue from asset sales. The medium term budget cements this breach – funds used to prop up the airline will not be replaced with funds from asset sales.</p>
<p>But the most menacing risk is the power utility Eskom, which is propped up by R350 billion in debt guarantees, but faces rising infrastructure costs, stagnant electricity demand and successive corruption scandals linked to state capture. Due to the scale of the commitments to Eskom, it will be impossible to contain the negative consequences if its lenders start refusing to rollover its debt. </p>
<h2>No political will</h2>
<p>Reading between the lines of the medium term budget, there is evidently no political will at the highest levels – the president and his cabinet – to do the right thing. The only reduction in planned expenditure is a cut to the contingency reserve. But responding to rising debt by reducing money for future emergencies is emblematic of the reluctance to take braver decisions like cutting the bloated, pointless ministries seemingly introduced by Zuma to employ his political cronies and their associates.</p>
<p>South Africa’s public finances are in dangerous territory and very difficult decisions will have to be taken before the 2018 budget if the situation is going to be stabilised. This will require politicians and civil servants who are competent and dedicated to the public interest to make bold decisions. Without such leadership the resultant trajectory will undermine the ideals and objectives of the post-apartheid era for many years to come.</p><img src="https://counter.theconversation.com/content/86362/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Seán Mfundza Muller received support from the Heinrich Boell Foundation to attend the Medium Term Budget Policy Statement, and provides advice to various civil society organisations and initiatives on public finance issues.</span></em></p>South Africa’s 2017 medium term budget reveals a growing gap between revenue and expenditure which places the country in a highly vulnerable financial state.Seán Mfundza Muller, Senior Lecturer in Economics, University of JohannesburgLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/840782017-09-18T16:20:11Z2017-09-18T16:20:11ZState owned enterprises shouldn’t be used as pawns in South African politics<figure><img src="https://images.theconversation.com/files/186178/original/file-20170915-8071-ce6kx6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's finance minister, Malusi Gigaba, has had to look towards selling off state owned assets to plug a fiscal hole</span> <span class="attribution"><span class="source">REUTERS/Rogan Ward</span></span></figcaption></figure><p>State owned enterprises are vital to many economies, but are particularly vital to those seeking economic development.</p>
<p>This is true in South Africa too. Which makes it odd that the South African government – and much of the policy debate – never sees any value in trying to work out what role they should play in growth and development.</p>
<p>Finance Minister Malusi Gigaba’s interest in <a href="http://www.fin24.com/Companies/Industrial/gigaba-could-target-pics-r14bn-telkom-stake-for-massive-saa-bailout-20170721">selling off</a> government shares in telecommunications group Telkom, to bail out South African Airways is the latest example of a trend in which state owned enterprises are seen as useful pawns in government plans but not as national assets whose use should be thought through carefully.</p>
<p>The importance of South African state owned enterprises was spelled out in a 2015 Organisation for Economic Cooperation and Development <a href="https://www.oecd.org/corporate/south-africa-state-owned-enterprise-reform.pdf">policy brief</a>. It estimated that their revenues correspond to 8.7% of the country’s gross domestic product. They also, it found, play a vital role in providing services:</p>
<blockquote>
<p>The population’s access to water, electricity, sanitation and transportation is almost entirely dependent on the state, operating through corporate vehicles. They are concentrated in strategic sectors – infrastructure, transport, energy and water – and are “among the main sources of employment” in cities.</p>
</blockquote>
<p>The Organisation for Economic Cooperation and Development might also have mentioned that State owned enterprises are also a key source of racial change. According to the <a href="http://www.labour.gov.za/DOL/documents/annual-reports/Commission%20for%20Employment%20Equity%20Report/2016-2017/commission-for-employment-equity-report-2016-2017">2016/17 report</a> of the Commission for Employment Equity, black people occupy just under 75% of top management jobs in state owned enterprises – black Africans 57%. In the private sector, the figure is 24.5 % - only 10.8% are black African.</p>
<p>Given this, one might expect that the government would make it a priority to work out what the most appropriate role for parastatals is in the economy’s development. But it isn’t a priority – nor has it ever been. </p>
<h2>Rule of short termism</h2>
<p>State owned enterprises have been seen as a route to private investment, enrichment for the connected or a site for political battles but never as a key element in the development mix. </p>
<p>In fairness, private interests have shown no great interest in debating the role of state owned enterprises either. They have preferred taking sweeping positions for or against privatisation. But, given state owned enterprise’s role in governance, government should take the lead in thinking through what State owned enterprises should do.</p>
<p>The reality is different. Gigaba’s interest in selling off government holdings in state owned enterprises has much more to do with pressures for patronage than placing privatisation back on the agenda some 15 years after president Thabo Mbeki was forced to <a href="http://ewn.co.za/2016/03/21/Mbeki-GEAR-programme-was-meant-to-save-SA-from-debt">ditch</a> it. It would be a strange turn if appeasing demands for public money revives a market friendly option which Mbeki had to abandon. And it certainly would not suggest a government committed to finding a development role for state owned enterprises.</p>
<p>It seems that the Mbeki government wanted to sell off shares in state owned enterprises not because it had a considered view that this would achieve the goals parastatals were designed to serve. The <a href="http://ewn.co.za/2016/03/21/Mbeki-GEAR-programme-was-meant-to-save-SA-from-debt">motive</a>, rather, seemed to be to enhance private investor confidence and state revenues. Many might support these goals. But neither has to do with a long-term view on the contribution these enterprises could make to the economy.</p>
<h2>A balancing act</h2>
<p>Nor has Gigaba revived privatisation because he and his advisors have thought through the role for state owned enterprises which his predecessors ignored. He is, rather, trying to balance the two pressures he has faced since he became minister earlier this year. </p>
<p>On the one hand, he does not want to become the latest finance minister to face <a href="http://www.fin24.com/Economy/live-can-dudu-myeni-legally-be-allowed-to-be-saa-chair-20170913">pressure</a> for not giving a state owned enterprise what it needs. On the other, he does not want to preside over a second round of rating <a href="https://theconversation.com/public-enterprises-played-a-big-part-in-south-africas-credit-ratings-downgrade-75745">downgrades</a> because he spent money the government did not have. The only way to square the circle is to sell off shares in one state owned enterprise (Telkom) to pay for the bailout in another, South African Airways. The government’s stake in Telkom is over <a href="https://www.moneyweb.co.za/news/companies-and-deals/telkom-cautions-shareholders-over-government-sale-talk/">39%</a>.</p>
<p>It’s hard to see how this strategy is sustainable. The South African Airways <a href="http://www.fin24.com/Economy/live-can-dudu-myeni-legally-be-allowed-to-be-saa-chair-20170913">bailout</a> request will not be the last. And it’s clearly not workable to keep on selling off national assets whenever state owned enterprises want cash injections. </p>
<p>Nor is this likely to protect the minister from political flak. There is sure to be principled opposition to the strategy and patronage politicians will also notice that the prospective piggy bank is being sold off and will rebel.</p>
<p>But even if Gigaba does manage to bring off the trick, it’s obvious that this move has everything to do with balancing political pressures and nothing to do with a development strategy. </p>
<p>Between Mbeki’s strategic retreat and Gigaba’s strategic balancing act, state owned enterprises have not been quiet backwaters. They have been, and still are, key battlegrounds in the war between the ruling party factions as officials and politicians in its patronage group try to turn them into vehicles for making deals and accumulating goodies while their opponents try to stop them. </p>
<p>Lately, this battle has been played out in parliament – first over the <a href="http://www.news24.com/SouthAfrica/News/sabc-inquiry-adopts-final-report-20170224">South African Broadcasting Corporation</a>, now over state owned power utility <a href="https://businesstech.co.za/news/government/178243/leaked-emails-show-exactly-how-the-guptas-captured-eskom-report/">Eskom</a>. South African Airways has been a battleground throughout and other state owned enterprises have been quieter sites of <a href="https://theconversation.com/corrupt-state-owned-enterprises-lie-at-the-heart-of-south-africas-economic-woes-79135">conflict</a>. </p>
<h2>Economy pays the price</h2>
<p>This trench warfare, in which both factions seeking control of the ANC make gains after pitched battles but neither ever wins the war, may shape the future of the ANC and government’s role in the economy. But again, the issue here is a political fight for power, not considered positions on the role of state owned enterprises.</p>
<p>The economy pays an obvious price for this failure to care about their development role – missed opportunities for growth and the exclusion of many who go without wages and salaries. But, given the factionalised nature of politics, which is likely to continue, it is unrealistic to expect serious thinking from the politicians on the role that state owned enterprises can play in growth and inclusion.</p>
<p>This makes it urgent that private interests take this issue much more seriously, replacing the stereotyped debate with considered proposals for change. State owned enterprises are too important to be relegated to pieces on a chessboard. But nothing is likely to change until everyone with an interest in the economy’s future develops ideas on how state owned enterprises fit in and presses politicians to take notice.</p><img src="https://counter.theconversation.com/content/84078/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steven Friedman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Privatisation talk in South Africa shows how state owned enterprises are being used as tools for enrichment by the connected and less as key elements of development.Steven Friedman, Professor of Political Studies, University of JohannesburgLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/826682017-08-22T15:06:28Z2017-08-22T15:06:28ZCentral bank case exposes incompetence of South Africa’s public protector<figure><img src="https://images.theconversation.com/files/182800/original/file-20170821-27163-1krbidt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa has been rocked by a legal battle between the country's Public Protector and Reserve Bank. </span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p><em>The South African Reserve Bank has won a critical <a href="https://www.timeslive.co.za/politics/2017-08-15-public-protector-should-reflect-on-her-conduct-court-says/">court battle</a>. The Pretoria High Court has set aside a
ruling by the country’s Public Protector that the central bank’s constitutional mandate should be changed. The Conversation Africa’s Sibonelo Radebe asked Jannie Rossouw to consider the implications of the court’s decision, and the events that led up to it.</em></p>
<p><strong>What do you read from this development?</strong></p>
<p>The judgment clearly shows the Public Protector, Busisiwe Mkhwebane, overstepped the mark in commenting on the constitutional mandate of another <a href="http://www.justice.gov.za/legislation/constitution/SAConstitution-web-eng-09.pdf">Article 9 institution</a>. South Africa has six independent Article 9 institutions which are designed to shore up constitutional democracy. These include institutions like the SA Reserve Bank, the South African Human Rights Commission, the Auditor-General, the Independent Electoral Commission – and the Public Protector itself.</p>
<p>It makes little sense for one of these institutions to want to influence the constitutional mandate of another. Left unchallenged, the Public Protector’s ruling would have led to an untenable situation. It would have implied that the Public Protector could usurp the role of the Constitutional Court. </p>
<p>This raises questions about the ability of the Public Protector to discharge her responsibilities competently and without fear or favour. The Public Protector’s office is meant to act in the best interests of all South Africans, not particular groups.</p>
<p><strong>Where does this case leave the public protector?</strong></p>
<p>The Public Protector should do the honourable thing and simply resign. She is clearly not fit to hold office and is now a national embarrassment. She is also doing damage to the stature of the office she holds.</p>
<p>Her incompetence raises questions about her ruling over two critical issues.</p>
<p>The first was that the constitutional mandate of the Reserve Bank should be amended, implying that the focus of the central bank should not be on inflation. Not only is this finding outside of the scope of her mandate, but it also shows a complete lack of understanding of the functions and policy limitations of a central bank. These could have been explained to her by any undergraduate economics student. She should have had the insight to understand that this mandate is prescribed by the Constitution.</p>
<p>It’s mind boggling that a person in her position could make such a bad mistake. </p>
<p>She also ruled that the Reserve Bank behaved irregularly in not reclaiming a bailout extended to <a href="https://theconversation.com/pursuing-a-30-year-old-bailout-is-sending-south-africa-on-a-wild-goose-chase-79792">Bankorp</a> in the 1980’s. She ordered Absa which acquired Bankorp to pay back the bailout money. Absa has filed an <a href="https://www.timeslive.co.za/sunday-times/business/2017-06-21-in-full-absa-goes-to-court-over-public-protector-report/">application</a> for this ruling to be set aside. </p>
<p>I’m of the view that she also erred in her Bankorp/Absa findings on a number of grounds. The most important are the time lapse since the assistance, which implies prescription and lapse of any claim in this matter. Moreover the Reserve Bank has assisted numerous banks in South Africa on various occasions without the imposition of the same sanction. It would be questionable justice to impose sanction over the Bankorp matter and not in any other instance where the Reserve Bank came to the rescue of banks.</p>
<p><strong>What are the political implications if any?</strong></p>
<p>The court’s judgement has saved South Africa from a <a href="https://theconversation.com/why-south-africas-public-protector-has-overstepped-her-mandate-80026">potential constitutional crisis</a> which would have caused further damage to investor confidence. </p>
<p>A number of key institutions like the Auditor General and the Independent Electoral Commission could be rendered vulnerable if the Public Protector were given free reign. These institutions are supposed to protect public interest but have come under attack in this era of <a href="https://theconversation.com/why-patronage-and-state-capture-spell-trouble-for-south-africa-64704">state capture</a>.</p>
<p>A number of public institutions, government departments and State owned enterprises, have been captured by forces acting in the narrow interest of politicians and their friends. This has placed the country in jeopardy. </p>
<p>Recent developments around the country’s treasury is a perfect example of how far the agents of state capture are prepared to go. South Africans watched with horror how the state capture agents bulldozed their way into the National Treasury. When the previous finance minister Pravin Gordhan stood against attempts to raid the public purse, he had to be <a href="https://theconversation.com/firing-of-south-africas-finance-minister-puts-the-public-purse-in-zumas-hands-75525">fired</a> and the conduct of his successor in the face of state capture is still subject to scrutiny.</p>
<p><strong>What are the economic implications if any?</strong></p>
<p>The South African Reserve Bank is one of few public institutions in South Africa <a href="https://theconversation.com/its-hard-to-get-rid-of-the-governor-of-a-central-bank-heres-why-64836">not tainted</a> by the Gupta-leaks. It therefore symbolises stability and confidence in the South African economy.</p>
<p>It means that the Bank will continue to discharge its constitutional responsibility and its independence is still safeguarded. Its independence serves to protect it from the whims of politicians.</p>
<p>It therefore implies that the bank will continue to focus on containing inflation as a consequence of its unchanged constitutional <a href="https://theconversation.com/why-south-africas-public-protector-has-overstepped-her-mandate-80026">mandate</a> which is to protect the value of the currency in the interest of balanced and sustainable economic growth.</p>
<p>This ruling will help to maintain some confidence in the South African economy, and will go some way towards restoring the slipping sovereign credit rating.</p>
<p>However, much more needs to be done before South Africa will once again have investment grade credit ratings from all major ratings agencies. For one thing, there must be greater policy certainty.</p><img src="https://counter.theconversation.com/content/82668/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jannie Rossouw previously worked for the SA Reserve Bank and holds shares in the SA Reserve Bank. He receives funding from the NRF as a C-rated researcher.</span></em></p>South Africa’s Public Protector, has been exposed as incompetent after trying to meddle with the constitutional mandate of the country’s central bank.Jannie Rossouw, Head of School of Economic & Business Sciences, University of the WitwatersrandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/780372017-05-19T04:15:30Z2017-05-19T04:15:30ZVIDEO: Michelle Grattan on the government’s budget sales job<figure><img src="https://images.theconversation.com/files/170067/original/file-20170519-12266-klye.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">AAP/David Mariuz</span></span></figcaption></figure><figure>
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<p>The University of Canberra’s vice-chancellor and president, Deep Saini, and professorial fellow Michelle Grattan discuss the week in politics, including the post-budget polls, how the banks will cope with the budget, Standard and Poor’s Global reaffirmation of a negative outlook, and how the issues with Donald Trump’s administration will affect Australia.</p>
<iframe src="https://www.podbean.com/media/player/jj7pe-6b2773?from=yiiadmin" data-link="https://www.podbean.com/media/player/jj7pe-6b2773?from=yiiadmin" height="100" width="100%" frameborder="0" scrolling="no" data-name="pb-iframe-player"></iframe><img src="https://counter.theconversation.com/content/78037/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The University of Canberra’s Deep Saini and Michelle Grattan discuss the week in politics.Michelle Grattan, Professorial Fellow, University of CanberraPaddy Nixon, Vice-Chancellor and President, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/765352017-05-16T00:11:39Z2017-05-16T00:11:39ZSouth Africa’s Reserve Bank is in the eye of a storm. Academics quiz the governor<figure><img src="https://images.theconversation.com/files/169306/original/file-20170515-6984-1jg5u3u.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's Reserve Bank Governor Lesetja Kganyago.</span> <span class="attribution"><span class="source">Reuters/Rogan Ward</span></span></figcaption></figure><p>Central banks everywhere play a critical role in shaping the direction of a country’s economy. The South African Reserve Bank is the central bank of South Africa. Its main mandates are to ensure financial and economic stability and to regulate the banking sector. It achieves the first thorough monetary policy which involves targeting inflation to prevent borrowing costs from rising and competitiveness of the economy from deteriorating. But the bank has been criticised for focusing too much on curbing inflation – it keeps inflation within a target range of 3% to 6% – at the expense of economic growth. And the banking regulation arm is also facing a barrage of questions. The Conversation Africa organised three economic scholars to pose questions to the Reserve Bank Governor Lesetja Kganyago.</p>
<hr>
<p><strong>Nimisha Naik, Wits University</strong> - <em>How should the Reserve Bank respond to the country’s recent credit rating <a href="https://theconversation.com/what-a-downgrade-means-for-south-africa-and-what-it-can-do-about-it-75704">downgrade</a>? What approaches can it take to limit the potential decrease in investments to South Africa?</em></p>
<p><strong>Lesetja Kganyago:</strong> A rating downgrade implies higher risk for investing in a
country. As such (everything else being equal) a higher return is required to attract the same amount of foreign capital necessary to finance South Africa’s current account deficit. </p>
<p>As markets shift to reflect the higher return needed, the country’s currency might weaken. This adjustment may be compounded by foreign funds having to divest from South Africa as their investment mandates prevent them from holding non-investment grade assets. </p>
<p>But a credit rating downgrade need not trigger a reaction from the Reserve Bank, unless its impact on capital flows and the exchange rate jeopardises price stability.</p>
<p>Raising the repo rate – the rate at which the central bank lends to commercial banks – by itself would do little to attract new investments. This is because only a small part of capital flows into the country consist of short-term money market investments. Most are made up of purchases of longer-term bonds and equities. </p>
<p>But failure to deal with the inflationary consequences of currency depreciation, which pushes up import prices and potentially all prices, would also push up both short and long term borrowing costs. This could eventually endanger the policy framework we have in place. As the commitment to low inflation weakens, investors will push up their expectations of future inflation, which further increases borrowing costs. This would, in turn, exacerbate capital outflows and push the currency down and prompt stronger inflation, in a vicious cycle.</p>
<p>The Reserve Bank has tended to think that, over time, such a negative outcome from a downgrade has become less likely. Market expectations of higher borrowing costs had already reached levels similar to those of lower-rated, non-investment grade countries even before the 3 April Standard and Poor’s <a href="https://theconversation.com/what-a-downgrade-means-for-south-africa-and-what-it-can-do-about-it-75704">rating event</a>. This implies that the market had mostly “priced-in” the downgrade. </p>
<p>Also, at the moment the global context is unusually supportive of emerging markets. Interest in riskier assets is being sustained by higher commodity prices and better global growth prospects. These factors in turn suggest that short-term selling of rand-denominated assets may be relatively muted.</p>
<p>Nonetheless, further downgrades, in particular to “local currency” ratings, would again lower prices of assets and raise the cost of financing in the economy. This would be clearly negative for South African borrowers, domestic financial institutions and economic growth more generally.</p>
<p><strong>Professor Alan Hirsch, University of Cape Town</strong> - <em>The recent budget showed that the National Treasury is tightening fiscal policy. Does this provide scope for monetary policy loosening?</em></p>
<p><strong>Lesetja Kganyago:</strong> There are two major channels through which fiscal policy tightening can interact with the monetary policy stance. Firstly, curbing private and public-sector spending growth normally dampens demand-driven price pressures. These are pressures caused when demand for goods and services cannot be easily met by increased production of those goods and services, resulting in higher prices for them. Secondly, reassuring investors about the medium-term sustainability of debt levels limits the risk of capital outflows – and therefore downward pressure on the rand. </p>
<p>The moderate tightening in South Africa’s fiscal stance over the past three to four years has gradually lowered the amount of annual borrowing from around 4% to about 3% of GDP. This is expected to continue over the next two years. </p>
<p>Some of this fiscal restraint has occurred through tax increases. Expressed as a share of pre-tax disposable income, <a href="http://www.treasury.gov.za/documents/national%20budget/2017/review/Chapter%204.pdf">direct household taxes</a> increased by 1.5 percentage points between 2012 and 2016. </p>
<p>Another part of the fiscal consolidation has happened through a nominal spending ceiling which is an absolute rand value for spending in a given year.</p>
<p>A sustainable fiscal trajectory for deficits and borrowing is an important influence on the cost of capital in the economy generally. Greater borrowing by the public authorities can put upward pressure on interest rates.</p>
<p>While government spending has contributed to South Africa’s recovery from the global recession of the 2009-2010 period, the impact of the higher cost of borrowing weighs more heavily on economic activity as borrowing continues year after year. This appears to be where the country is now. Spending contributes less than it did earlier to sustained economic growth, in part because the cost is higher. </p>
<p>As a contribution to short-term economic growth, government and private debt has probably become a constraint. Fiscal space is being re-opened as government debt levels stabilise and the economy’s growth rate strengthens. <a href="http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7718/02Quarterly%20Economic%20Review%20%E2%80%93%20March%202017.pdf">Household debt levels</a> have also come down in recent years, especially in 2016. This also creates space for stronger consumption growth over the longer-term.</p>
<p>As the fiscal consolidation progresses and deficits work down, both inflation and interest rates should moderate. This is helpful to monetary policy. It has, and should, continue to facilitate the Reserve Bank’s gradual and flexible approach to getting inflation sustainably down towards the middle of the target band of 3% to 6%.</p>
<p><strong>Professor Alan Hirsch</strong> - <em>As global interest rates rise this year, will the Reserve Bank be able to delay reciprocal increases in order not to stifle South Africa’s meagre growth. And to allow its currency to continue to favour exporters?</em></p>
<p><strong>Lesetja Kganyago:</strong> The rise in global interest rates will tend to depreciate other currencies, except those of economies that will get a strong and direct growth benefit from more robust growth in the US. But domestic conditions are critically important. The inflation targeting framework provides room for flexibility, allowing the Monetary Policy Committee to choose what weight to place on external and internal factors in deciding policy. </p>
<p>Policy is not bound to follow interest rate decisions of major central banks. This is unlike countries that use the exchange rate targeting framework for achieving low inflation. As the Monetary Policy Committee has noted, domestic economic growth has been weak and this requires policy settings that are supportive. For these reasons, “de-coupling” of interest rates is a common feature of growth and policy cycles. </p>
<p>This implies that some currency depreciation has been expected in recent years. And indeed this has happened. In this context it’s been important for policy to focus on whether depreciation will generate future inflation. Up to now we have been fortunate this “pass-through” into domestic prices has been less than would normally be expected. </p>
<p>This may, in part, be because of lower commodity prices and terms of trade and the more generally weak economy. The upshot is that we have gained competitiveness as the nominal exchange rate has depreciated, without much stronger growth in domestic inflation. This has helped to keep interest rates at near historically low levels since 2010. This has supported the recovery in the economy, while still keeping expectations of future inflation just within the target band.</p>
<p><strong>Professor Jannie Rossouw, Wits University.</strong> - <em>Does the existing structure of private shareholders still serve the best interest of the Reserve Bank and South Africa?</em></p>
<p><strong>Lesetja Kganyago:</strong> The Reserve Bank’s shareholding <a href="http://www.resbank.co.za/AboutUs/History/Background/Pages/OwnershipOfTheSouthAfricanBank.aspx">structure</a> is unusual, yet not unique in the world of central banking. At present, eight central banks in the world have a degree of private ownership. These include the US Federal Reserve, the Bank of Japan and the Swiss National Bank. </p>
<p>Historically, most central banks were privately-owned. This pattern changed drastically after the Great Depression of the 1930s. Back then, many governments felt that the <a href="http://www.bis.org/publ/work326.pdf">conflict</a> between private shareholders’ interests and the public policy mandate of these institutions had in some cases prevented appropriate policy responses.</p>
<p>But several safeguards ensure that the Reserve Bank’s shareholding structure does not pose such risks in South Africa. In fact, the Reserve Bank’s private shareholders have no influence on the Reserve Bank’s key mandates of price and financial stability. </p>
<p>The Governor and his or her deputies are appointed by the president of the country. And the <a href="https://www.resbank.co.za/AboutUs/Legislation/Pages/default.aspx">SA Reserve Bank Act</a> can only be amended by Parliament. The Reserve Bank’s functional independence is enshrined in the Constitution. Equally, as per the spirit of the constitution, the inflation targeting framework has been determined through a consultative process between National Treasury and the Reserve Bank.</p>
<p>Provisions of the Act further stipulate that no individual shareholder, including his or her associates, can hold more than 10,000 of the existing 2 million shares. It also caps the dividend at 10c/share. These prevent any attempt by shareholders at extracting significant profits from the institution, for instance through the sale of its assets.</p>
<p>Overall, the role of the Reserve Bank’s private shareholders remains one of oversight and can improve governance. This happens, for example, through the tabling of an annual report and financial statements at the annual general meeting of shareholders. </p>
<p>While international experience does not suggest that the shareholding structure of a central bank meaningfully affects its performance, there is equally no obvious case for changing such a structure in South Africa at present.</p>
<p><strong>Professor Jannie Rossouw</strong> - <em>What needs to happen before there can be a debate about a lower inflation target, say 3% - 5%?</em></p>
<p><strong>Lesetja Kganyago:</strong> South Africa’s inflation target range is both relatively wide and high by international standards, including among emerging countries. At the time the 3%-6% target <a href="https://www.resbank.co.za/MonetaryPolicy/DecisionMaking/Pages/default.aspx">was adopted</a> in the early 2000s, South Africa remained an economy in transition, having recently faced renewed exposure to global economic volatility.</p>
<p>The economy was thus exposed to shocks, and it was felt that a relatively wide and high target would be more credible in such a vulnerable environment. The strategy seems to have borne fruit: compliance with the target has improved over time despite greater currency volatility. Inflation, as well as inflation expectations and wage growth, display lesser volatility than in the early years of the targeting regime. And the policy appears to have gained growing acceptance, over the years, from respective stakeholders. </p>
<p>But a relatively wide target can create uncertainty as to the actual objectives of monetary policy. In the South African case, this lack of clarity has resulted in an anchoring of inflation expectations at the upper end of the target range, which now restrains the margin of policy manoeuvre in the event of exogenous shocks. </p>
<p>In addition, the <a href="http://www.inflation.eu/inflation-rates/south-africa/historic-inflation/cpi-inflation-south-africa.aspx">persistence of higher inflation </a> in South Africa relative to its major trading partners introduces a medium-term depreciation bias to the currency, which will raise the risk premium on domestic interest rates. Achieving a lower inflation rate would help ease these constraints on the economy. Whether a more efficient target (using a point, a lower target, or being more explicit about where in the band is the best inflation rate) could help achieve such an outcome is an open question for economists to consider.</p>
<p>The target was <a href="http://wwwapp.reservebank.co.za/internet/Publication.nsf/LADV/E1BAD4FBC856AE9042256EF40046DEBB/$File/OCCNo19.pdf">revised to 3%-5%</a> in 2001 but after the currency depreciation that same year the range was revised back to 3%-6% with the proviso that once inflation is back within the target then the 3%-5% target range will be reinstated. This has not happened yet.</p>
<p><strong>Professor Alan Hirsch</strong> - <em>What has the Reserve Bank learned from the <a href="https://www.ft.com/content/75fccfd8-f8d6-11e6-9516-2d969e0d3b65">Barclays/ABSA saga</a>? Will it be more circumspect in allowing foreign investors to buy thriving South African banks in the future?</em></p>
<p><strong>Lesetja Kganyago:</strong> The Barclays Plc separation from Barclays Africa Group (trading in South Africa as Absa Bank) has renewed the policy debate on foreign ownership of the large South African banks at the Reserve Bank. The debate is also back because of the regulatory reforms imposed by the <a href="http://www.bis.org/bcbs/about.htm">Basel Committee</a> and the <a href="http://www.fsb.org">Financial Stability Board</a> on <a href="http://www.fsb.org/2016/11/2016-list-of-global-systemically-important-banks-g-sibs/">global systemically important banks</a> following the global financial crisis. </p>
<p>These reforms imposed various additional requirements on global systemically important banks. This has filtered down to their significant subsidiaries operating in different jurisdictions, including emerging markets. These subsidiaries then need to compete with other local banks that don’t need to meet those global systemically important banks requirements, contributing to an uneven playing field.</p>
<p>The Reserve Bank is supportive of and welcomes foreign ownership of South Africa’s large banks. But it remains cautious against controlling ownership by a global systemically important bank, as this could result in onerous regulatory requirements being imposed on the local operation.</p>
<p>The actual separation is also closely monitored as the local banking operations have become closely aligned and integrated on IT systems, infrastructure and processes with their parents. As such any separation needs to ensure that the local subsidiary remains operationally stable during and after the separation.</p>
<p>When the Banking Registrar assesses new investors applying to acquire a stake in any bank, its office conducts a fit-and-proper assessment. This is to establish the strategic intent of these investors. It’s to see whether the investment is expected to be long-term in nature, how the investment will be funded and how the investors plan to fulfil their fiduciary duties, including in terms of governance.</p><img src="https://counter.theconversation.com/content/76535/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jannie Rossouw own shares in the SA Reserve Bank and previously worked for the central bank. He receives research funding from the NRF.</span></em></p><p class="fine-print"><em><span>Alan Hirsch and Nimisha Naik do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The South African Reserve Bank has come under spotlight due to the critical role it must play in enabling the country to navigate rough waters. Governor Lesetja Kganyago shares his views.Nimisha Naik, Lecturer in Economics, Macroeconomics and Mathematical Economics, University of the WitwatersrandAlan Hirsch, Professor and Director of The Nelson Mandela School of Public Governance, University of Cape TownJannie Rossouw, Head of School of Economic & Business Sciences, University of the WitwatersrandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/757062017-04-04T11:36:35Z2017-04-04T11:36:35ZAfter the downgrade: South Africa should copy Brazil and impeach its president<figure><img src="https://images.theconversation.com/files/163832/original/image-20170404-5732-dzao8l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's President Jacob Zuma looks on as his new cabinet members are sworn in.</span> <span class="attribution"><span class="source">Reuters/Siphiwe Sibeko</span></span></figcaption></figure><p>The news that South Africa’s sovereign rating has been <a href="http://www.fin24.com/Economy/breaking-sp-downgrades-sa-to-junk-status-20170403">downgraded</a> caught many by surprise. But it was long coming. The main reason for the rating agency’s decision is clearly concerns about political leadership in the country. Moody’s, which is expected to follow suit, has <a href="https://www.moodys.com/research/Moodys-places-South-Africas-Baa2-ratings-on-review-for-downgrade--PR_364595">said</a> as much, stating its decision to put the country on a negative outlook down to “the abrupt change in leadership of key government institutions”.</p>
<p>The downgrade by S&P comes on the back of a highly charged political environment in the ruling African National Congress. This culminated in the <a href="http://www.news24.com/SouthAfrica/News/why-zuma-reshuffled-his-cabinet-20170402-2">sacking</a> of the finance minister Pravin Gordhan and his <a href="http://www.ujuh.co.za/zumas-cabinet-reshuffle-points-to-the-rise-of-malusi-gigaba/">replacement</a> with Malusi Gigaba. While the <a href="https://theconversation.com/firing-of-south-africas-finance-minister-puts-the-public-purse-in-zumas-hands-75525">cabinet reshuffle</a> is the proximate cause of the downgrade, South Africa’s political and institutional malaise goes deeper.</p>
<p>So how does the country surf through these turbulent waters? </p>
<p>One hopes that the credit downgrade could help to focus the mind of the country’s political leadership to the task at hand, and that this will inject much-needed urgency for political change and economic reforms. The S&P assessment <a href="https://www.standardandpoors.com/en_US/web/guest/ratings/search/-/search/searchType/E/searchTerm/south%20africa">casts a ray of hope</a>:</p>
<blockquote>
<p>We could revise the outlook to stable if we see political risk reduced and economic growth or fiscal outcomes strengthen compared to our baseline projections. </p>
</blockquote>
<p>Piecemeal efforts towards change will not be enough. Bold leadership is required. But it’s inconceivable that the kind of action required can happen under President Jacob Zuma’s leadership. </p>
<p>The real chance to turn the country around is to do precisely what the Brazilians did last year – to <a href="http://www.bbc.com/news/world-latin-america-37237513">impeach</a> the president while building momentum in civil society to achieve political renewal as the basis for sustained economic recovery. </p>
<h2>South Africa failed to heed warning signs</h2>
<p>For nearly a decade now, international financial institutions and other international organisations have warned South Africa about a number of dangers. These include policy uncertainty, the consequences of low growth for social stability, and the need to attend urgently to industrial relations, especially in the mining sector. </p>
<p>Dire warnings are contained in a number of reports. These include the International Monetary Fund’s latest annual <a href="https://www.imf.org/en/News/Articles/2016/07/11/13/25/PR16322-South-Africa-IMF-Executive-Board-Concludes-2016-Article-IV-Consultation">assessment</a> of South Africa’s macro-economic conditions, the Organisation of Economic Cooperation and Development (OECD) <a href="http://www.oecd.org/eco/surveys/South-Africa-OECD-economic-survey-overview.pdf">periodic survey</a> and the World Bank Economic <a href="http://www.worldbank.org/en/country/southafrica/publication/south-africa-economic-update-promoting-faster-growth-poverty-alleviation-through-competition">Update</a>. </p>
<p>South Africa experienced downgrades in <a href="https://www.moodys.com/research/Moodys-downgrades-South-Africas-government-bond-rating-to-Baa1-outlook--PR_256159">2012</a>, <a href="http://www.treasury.gov.za/comm_media/press/2013/2013011101.pdf">2013</a> and <a href="http://www.stanlib.com/EconomicFocus/Pages/FitchdecidedtodowngradeSouthAfricascreditratingtoBBB.aspx">2015</a>. These should have been read as a harbinger of worse things to come. Government had ample time to draw appropriate lessons from these warnings, but chose to stick its head in the sand in the hope that problems would varnish. Meanwhile, the ruling party elevated factional battles above interest of the country. </p>
<p>South Africa could have also drawn lessons from Brazil which was downgraded by S&P and Moody’s to <a href="http://www.reuters.com/article/us-brazil-ratings-s-p-idUSKCN0RA06120150910">sub-investment grade status</a> in 2015 . This was in the wake of political unrest over a massive <a href="http://www.bbc.com/news/world-latin-america-35810578">corruption scandal </a>at the oil giant Petrobas, declining business confidence, growing policy uncertainty and President Dilma Rousseff’s weak leadership. </p>
<p>The downgrade further worsened Brazil’s growth outlook, with capital fleeing the country. Less than a year later after the downgrade, the Senate had thrown Rousseff <a href="https://www.theguardian.com/world/2016/aug/31/dilma-rousseff-impeached-president-brazilian-senate-michel-temer">out of office</a>.</p>
<h2>What’s to follow the downgrade</h2>
<p>In a sense, credit downgrades shouldn’t come as a surprise. They are like a medical report showing defects in the vital organs in the body while the patient is still alive and can do something about them, albeit requiring uncomfortable surgical procedure and a strong dose of medication. </p>
<p>In evaluating South Africa, S&P took into account the effectiveness of policymaking and stability of political institutions to respond effectively to socio-economic challenges, and found these wanting. The S&P <a href="http://ewn.co.za/2017/04/03/read-the-full-standard-and-poors-statement-south-africa-credit-rating-junk-status">statement</a> specifically singled out the risk of cabinet reshuffle on fiscal and growth outcomes, the possibility of increase in the contingent liabilities of the state – in particular the likelihood of state-owned enterprises such as <a href="https://theconversation.com/why-south-africas-power-utility-isnt-in-great-financial-shape-68441">Eskom</a>, the power utility, to draw down on government guarantees – and increased political risks in general in the current year. </p>
<p>The consequences of this downgrade are not difficult to discern: they will trigger a disposal by pension funds and other institutional investors of South African debt, since these funds are not allowed to hold sub-investment grade (or speculative) bonds. Sub-investment grade status will increase South Africa’s borrowing costs from global markets. </p>
<p>Interest rates are likely to go up, with debt-laden consumers bearing the brunt. Capital will flee in search of safer havens for healthy returns. </p>
<p>There are political implications too. Government spending will be constrained, including for welfare programmes and delivery of various public services, raising prospects of waves of political unrest in the run up to 2019 elections. </p>
<p>And there’s likely to be more pressure on the government to increase public servants’ salaries. </p>
<p>Further accentuating the strain on the economy is the fact that growth is likely to remain in the doldrums; with the employment outlook remaining bleak for the foreseeable future. Export growth is projected to remain flat during 2017 and 2020. As S&P notes, economic growth is unlikely to come from business investment, since business will be withholding capital in the face of heightened political risk. </p>
<h2>Solutions</h2>
<p>Bold political and economic reforms are urgently needed. Tough times such as the ones South Africa is headed can also be crucibles for transformative leaders who are willing to break rank from the small-mindedness of their parties, and chart a different course that delivers real change. </p>
<p>Zuma has already squandered his credibility, and showed himself as out of kilter with the realities of the economy. The major task of pushing for structural reforms in the economy and to restore stability lies with the Minister of Finance, who ideally should have relative autonomy from the president and able to corral his cabinet colleagues to behave responsibly. Disappointingly, Malusi Gigaba, the new minister, started on a bad footing, peddling <a href="http://www.treasury.gov.za/comm_media/speeches/2017/2017040101%20Speech%20by%20Minister%20of%20Finance%20Malusi%20Gigaba%20on%20his%20new%20Portfolio.pdf">rhetoric</a> and taking ambiguous and contradictory positions in his early days in office. </p>
<p>So what would a package of reforms look like? Government needs to send a clear and strong message about the direction of economic policy. This must be followed by a bold set of actions that could immediately restore confidence and gain the support of the private sector. There’s also a need to restructure state-owned enterprises, improve efficiencies and restore good corporate governance.</p><img src="https://counter.theconversation.com/content/75706/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Mzukisi Qobo does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The best chance South Africa has of recovering from sub-investment grade credit rating status is to have leaders who are prepared to break rank with the small-mindedness of the ruling party.Mzukisi Qobo, Deputy Chair: SA Research Chair on African Diplomacy and Foreign Policy, University of JohannesburgLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/755492017-03-31T12:01:19Z2017-03-31T12:01:19ZSouth Africa has lost a key line of defence against corruption. What now?<figure><img src="https://images.theconversation.com/files/163448/original/image-20170331-31747-shdpgu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The sacking of South Africa's Finance Minister Pravin Gordhan has created uncertainty about the future of the country's finances.</span> <span class="attribution"><span class="source">Nic Bothma/EPA</span></span></figcaption></figure><p>South Africa’s currency and bond markets <a href="https://www.bloomberg.com/news/articles/2017-03-30/south-africa-s-rand-extends-slump-as-zuma-fires-finance-minister">plunged</a> after a dramatic late night <a href="http://www.thepresidency.gov.za/press-statements/president-zuma-appoints-new-ministers-and-deputy-ministers">announcement</a> that South Africa’s President Jacob Zuma had fired the Finance Minister Pravin Gordhan and his deputy Mcebisi Jonas as part of a major cabinet reshuffle. </p>
<p>It’s no exaggeration to say that the removal of the finance minister is the greatest threat to public finances experienced in democratic South Africa. </p>
<p>Let’s be clear, the motive for removing the minister and his deputy had nothing to do with the responsible and safe management of South Africa’s economy. Rather it has everything to do with Gordhan and his team’s intent to safeguard the fiscus against irresponsible and corrupt activities. It follows that whoever replaces them will be amenable to facilitating such activities.</p>
<p>It’s hard to overstate the harm that a corrupt finance minister could cause. The first consequence – which became apparent when Nhlanhla Nene was <a href="http://www.fin24.com/BizNews/zumas-blunder-on-nene-costs-sa-billions-when-will-taxpayers-call-enough-20151213">fired</a> and also as speculation mounted about Gordhan’s removal – is based on a simple loss of confidence. This is reflected in the <a href="https://www.bloomberg.com/news/articles/2017-03-30/south-africa-s-rand-extends-slump-as-zuma-fires-finance-minister">sharp depreciation</a> of the rand before and after Zuma’s announcement.</p>
<p>The rand is likely to suffer further. The cost of government borrowing in the market will rise, further compounding the impact of a formal downgrade by ratings agencies which is likely to follow. Higher borrowing costs will mean less money for expenditure, along with a reduced ability to borrow. Imports will become more expensive, potentially fuelling inflation and a hike in interest rates. </p>
<p>There’s also likely to be an outflow of foreign investment, further exacerbating the weakened exchange rate. At its most extreme this could lead to a balance of payments crisis. All of this will harm already low economic growth.</p>
<p>And there are a number of key decisions – such as the approval of an expensive nuclear deal – that could get the green light, severely damaging the country’s fiscal position.</p>
<h2>So why now</h2>
<p>When Zuma <a href="https://www.businesslive.co.za/bd/opinion/2017-03-28-zuma-recalls-gordhan-from-high-profile-roadshow-as-the-world-watches/">summoned</a> Gordhan back from an investor roadshow in the UK earlier in the week, he is said to have to have acted on the back of a flimsy <a href="http://www.heraldlive.co.za/news/2017/03/29/zuma-justify-gordhan-axing-intelligence-report-sources/">intelligence report</a>. Few believe this to be the real reason.</p>
<p>Others speculated that Zuma’s reason for making the move now might be linked to court cases involving the Gupta family and their associates, or the manufactured crisis relating to the distribution of social grants. </p>
<p>The <a href="http://www.fin24.com/Economy/zuma-joins-gupta-court-battle-to-file-motion-against-bank-20170327">court cases</a> relate to attempts by the Guptas to get the executive branch to intervene in the decision of commercial banks to close their bank accounts. They are also linked to an attempt by the Gupta’s associates to <a href="http://citizen.co.za/news/news-national/1471048/treasury-to-respond-to-gupta-associates-bank-bid/">purchase</a> a controlling share in an existing bank. There certainly seems to be a sense of urgency, with the last bank servicing Gupta companies reported to have started closing accounts. </p>
<p>But my premise on why this has happened now is much simpler. The timing of it ensures that the new finance minister, and other new appointments, have a month’s grace before a vote of no confidence in parliament can be tabled in parliament. Two opposition parties have already called for one. </p>
<p>A vote of no confidence against Zuma could succeed if the ANC caucus turned on Zuma and ANC members joined opposition parties to make up a 51% majority. There were hints of such a <a href="https://theconversation.com/zuma-lives-to-fight-another-day-but-fallout-from-latest-revolt-will-live-on-69587">revolt</a> in February ahead of Gordhan’s budget speech. The chances of it actually happening this time are probably much greater.</p>
<p>But an imminent vote isn’t possible because parliament starts its 2017 Easter <a href="https://www.parliament.gov.za/storage/app/media/Programmes/parliamentary-programme-framework-2017.pdf">recess</a> on the 31st of March, and only returns in early May. My reading of the Constitution and the Rules of the National Assembly suggests that recalling parliament before the recess ends will be difficult, if not impossible. That means that in the absence of some other process to block the president’s machinations, his cronies will have a minimum of four weeks to implement whatever nefarious plans they have devised for the finance ministry.</p>
<p>A lot of damage could be done in that time. </p>
<h2>Harm that can be done</h2>
<p>The consequences of Gordhan’s removal could be potentially dire on a number of fronts. They include, for example, the finance ministry withdrawing from its involvement in various court cases relating to the Gupta family. </p>
<p>Other possible consequences include the worsening of <a href="http://www.fin24.com/Economy/sars-at-risk-of-imploding-20170305-2">mismanagement</a> of the South African Revenue Services and untrammelled corruption at state-owned enterprises. </p>
<p>The approval of the expensive and unnecessary nuclear deal also becomes a real possibility. Eskom already holds hundreds of billions of rand in <a href="https://theconversation.com/why-south-africas-power-utility-isnt-in-great-financial-shape-68441">debt guarantees</a> from the National Treasury and the nuclear deal would likely be financed through the issuing of further such guarantees. </p>
<p>The combination of irresponsibly issued and utilised guarantees, along with an increase in borrowing costs, a ratings downgrade and falling revenue collection, would lead to a dramatic worsening in various public finance metrics, such as the debt-to-GDP ratio. </p>
<p>Corresponding harm could be done to critical institutions that fall under the Ministry of Finance. These include the <a href="http://www.gepf.gov.za/">Government Employees Pension Fund</a> and the <a href="http://www.pic.gov.za/">Public Investment Corporation</a> which are responsible for trillions of rand in public sector pensions. Institutions like the <a href="https://www.fic.gov.za/Pages/Home.aspx">Financial Intelligence Centre</a> and <a href="https://www.fsb.co.za/Pages/Home.aspx">Financial Services Board</a> could also be compromised. And there are significant funds that could be appropriated or misdirected from development finance institutions such as the <a href="http://www.landbank.co.za/">Land Bank</a> and <a href="http://www.dbsa.org/EN/Pages/default.aspx">Development Bank of Southern Africa</a>.</p>
<h2>Where to from here?</h2>
<p>As long as principled, competent public servants remain at the helm of the country’s National Treasury it might be harder for the new minister of finance to engage in corrupt, illegal or irrational actions. To do so he would have to suspend or dismiss numerous officials leaving himself open to legal action on various grounds, including labour law. The presence of good officials also means that there is greater scope for whistleblowing which could inform action by civil society, the judiciary and the legislature.</p>
<p>In principle, parliament should be able to exercise significant oversight over the National Treasury, including the budget. But Parliament’s primary source of technical support has shown itself to be <a href="https://theconversation.com/explainer-the-nitty-gritty-of-south-africas-annual-budget-72901">unable or unwilling</a> to tackle politically sensitive issues. On top of this the Financial and Fiscal Commission, which also advises parliament committees on such matters, currently has no permanent leadership. </p>
<p>It therefore remains to be seen whether there’s sufficient political will and technical competence in the legislature to significantly mitigate the harm that the recent reshuffle will cause. In that context, the best South Africans can hope for is that somehow the harm can be minimised for four weeks, and that the president and his new cabinet are removed shortly afterwards.</p><img src="https://counter.theconversation.com/content/75549/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Seán Mfundza Muller is affiliated with the Public and Environmental Economics Research Centre (PEERC) at the University of Johannesburg, and previously worked for the Parliamentary Budget Office.</span></em></p>The removal of South Africa’s finance minister, Pravin Gordhan, is the greatest threat to public finances experienced in the post 1994 era.Seán Mfundza Muller, Senior Lecturer in Economics, University of JohannesburgLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/755502017-03-31T07:59:36Z2017-03-31T07:59:36ZStakes for South Africa’s democracy are high as Zuma plunges the knife<figure><img src="https://images.theconversation.com/files/163423/original/image-20170331-16307-tru6ql.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's President Jacob Zuma has shafted and shifted 20 cabinet posts.</span> <span class="attribution"><span class="source">Aaron Ufumeli/EPA</span></span></figcaption></figure><p>South Africa has reached a crisis point in its political history that’s been looming on the horizon for more than a year. In the dark of night – literally – President Jacob Zuma demonstrated his ruthlessness by firing finance minister, Pravin Gordhan, amid a <a href="http://www.iol.co.za/news/politics/zuma-names-10-new-ministers-10-new-deputies-8424900">20-person</a> reshuffle of his government.</p>
<p>The magnitude of what has happened shouldn’t be underestimated. The Save South Africa campaign, echoing the sentiments of the country’s progressive-minded constitutionalists, described Gordhan’s dismissal as <a href="https://www.biznews.com/leadership/2017/03/31/comment-zumas-night-of-long-knives-gordhan-out-gupta-associates-in/">“an outrage”</a>.</p>
<p>There are two major concerns. The first is the impact on the economy, the second is a political and democratic one.</p>
<p>It’s not hyperbolic to suggest that what happens next – in the coming hours and days – will determine whether South Africa’s hard-won democracy will survive or whether it will join the club of post-colonial calamities that have scarred the continent’s past. The stakes couldn’t be higher.</p>
<h2>Threat to the economy</h2>
<p>In the last few months South Africa’s economy had begun to show the very first signs of <a href="http://m.fin24.com/fin24/Economy/live-gupta-bank-court-battle-set-to-begin-20170328">strengthening</a>. Gordhan, in fact, had just embarked on an investor roadshow to further encourage much-needed investment when, on Monday, Zuma ordered him to <a href="http://www.timeslive.co.za/politics/2017/03/27/BREAKING-Zuma-orders-Gordhan-to-return-from-unauthorised-UK-roadshow-cancels-Jonas-US-trip">return</a>.</p>
<p>Zuma has been waging a cold war against his finance minister for <a href="https://theconversation.com/prexit-as-south-africa-looks-over-the-abyss-who-will-blink-66969">over a year</a>, causing uncertainty and undermining attempts to convince markets and <a href="http://www.fin24.com/Economy/no-change-in-south-africas-credit-rating-moodys-20161126">rating agencies</a> alike that South Africa’s government was doing all it could to shake the country out of the economic rut into which it has fallen since the <a href="https://www.forbes.com/2009/01/14/global-recession-2009-oped-cx_nr_0115roubini.html">global economic crisis</a> almost ten years ago.</p>
<p>Gordhan and his team of public servants at National Treasury stood between Zuma and his cronies’ most nefarious and venal plans – such as a <a href="http://www.fin24.com/Economy/why-governments-nuclear-deal-will-destroy-sa-20160915">nuclear deal</a> with Russia. As South Africa’s former Public Protector (ombudsman) described in her seminal report, “<a href="https://www.da.org.za/2016/11/download-public-protectors-state-capture-report/">State of Capture</a>”, the Gupta family and other rent-seeking opportunists have been exploiting Zuma and his family’s weakness and taking control of important institutions and agencies of the state, such as the <a href="http://www.sars.gov.za/Pages/default.aspx">tax authority</a> (SARS), the <a href="https://www.npa.gov.za/">national prosecuting authority</a> (NPA) and state energy utility, <a href="http://www.eskom.co.za/Pages/Landing.aspx">Eskom</a>.</p>
<p>Gordhan has heroically withstood the intimidation and held the line. The rand has already <a href="http://www.sabc.co.za/news/a/69589e80409ab28eb279f242beef4d8c/Rand-plunges-after-Gordhan-sacked-20170331">plunged</a> on news of his removal. Market sentiment will collapse. And there’s a high likelihood that perhaps as early as next week, rating agency Moody’s will downgrade South Africa to <a href="http://www.fin24.com/Economy/junk-status-on-the-cards-after-zumas-night-of-long-knives-20170331">junk status</a>. This will, in turn, increase the cost of government borrowing and set in motion a sequence of economic events that will cause great harm to the poorest and most vulnerable members of society.</p>
<h2>Political and democratic concerns</h2>
<p>Gordhan’s removal is an act of <a href="http://ewn.co.za/2017/03/29/opinion-judith-february-president-zuma-is-holding-sa-to-ransom">democratic disregard</a> and political as well as economic recklessness. While the two main opposition parties, the <a href="https://www.da.org.za/">Democratic Alliance</a> and the <a href="http://www.economicfreedomfighters.org/">Economic Freedom Fighters</a>, both reacted by tabling motions of <a href="http://citizen.co.za/news/news-national/1471914/da-to-table-motion-of-no-confidence-in-zuma/">no confidence</a> in the national assembly, the focus will now be on how the social democratic and left-leaning members of cabinet – the “constitutionalists” – will respond to last night’s events.</p>
<p>They will be under pressure to resign <a href="http://www.news24.com/Columnists/AdriaanBasson/zuma-vs-pravin-is-it-checkmate-20170329">in solidarity</a> with Gordhan, but they will also be anxious about vacating the space to the nationalist populists who now hold a big majority in government.</p>
<p>But this is no longer about ideology. It’s as several senior ANC insiders have described to me in recent days as being about “the corrupt versus the non-corrupt”.</p>
<p>That there will be a fight back against Zuma’s reckless decision is beyond doubt. One of the fired ministers wrote to a friend late last night: “we will get the bastard”. But to “get Zuma” they will have to show the same ruthlessness and courage, and they will have to act decisively and fast.</p>
<p>All eyes will be on deputy president, <a href="http://ewn.co.za/2017/01/08/the-debate-over-who-should-succeed-zuma-as-anc-president-heating-up">Cyril Ramaphosa</a>, one of two contenders to succeed Zuma at the ANC’s five-yearly national elective conference in<a href="http://www.huffingtonpost.co.za/2017/01/22/the-battle-for-limpopo-is-on-head-of-anc-elective-conference/"> December</a> this year. </p>
<p>When Zuma told the ANC’s top six leadership of his decision to remove Gordhan earlier this week, Ramaphosa and Secretary General Gwede Mantashe <a href="http://www.news24.com/SouthAfrica/News/ramaphosa-mantashe-rejected-zumas-reasons-for-axing-gordhan-20170331">objected</a>. They rejected out of hand the “evidence” that Zuma put before them – a self-evidently <a href="http://citizen.co.za/news/news-national/1471284/gupta-manufactured-report-made-zuma-recall-gordhan/">fake piece of intelligence</a> that Zuma claimed showed that Gordhan was in London to persuade investment banks to help him topple Zuma.</p>
<p>As Gordhan flew through the night on Monday, events intervened: ANC stalwart and liberation hero, Ahmed Kathrada, <a href="http://www.enca.com/south-africa/struggle-stalwart-ahmed-kathrada-dies-aged-87">passed away</a>. Zuma was compelled to press the pause button on his reshuffle plans. At Kathrada’s funeral on Wednesday, many of the ANC’s top leadership gathered to hear former president Kgalema Motlanthe read out the letter from Kathrada that called for Zuma to <a href="https://www.enca.com/south-africa/standing-ovation-as-motlanthe-quotes-kathradas-call-for-zuma-to-step-down">resign</a>.</p>
<p>When Gordhan was acknowledged, the mourners <a href="https://www.businesslive.co.za/bd/national/2017-03-29-stoic-gordhan-gets-standing-ovation-at-funeral-of-anc-stalwart-kathrada/">rose </a> as one in support: a powerful, as well as emotional moment. Zuma was conspicuous by his absence: it had been made clear to him by Kathrada family that <a href="https://mg.co.za/article/2017-03-28-president-zuma-barred-from-kathrada-funeral">he was not welcome</a>.</p>
<h2>Is South Africa’s democracy under threat?</h2>
<p>The ANC has never been more painfully divided, to the point where it’s very future is threatened. It could split. It may not maintain its majority at the next national election in 2019. All bets are off.</p>
<p>And, in the long run, this may not be a bad thing. As every hour has passed since Zuma won the ANC’s presidency in <a href="https://mg.co.za/article/2007-12-18-zuma-is-new-anc-president">December 2007</a>, it has declined as a progressive, stabilising force for good amid the turbulent, violent precariousness and social incohesion of South Africa’s noisy democracy.</p>
<p>Is that democracy now under threat? This is the biggest question now, which cannot be ignored.</p>
<p>Is South Africa sleepwalking towards the door marked “dictatorship”? Repeatedly, the analyst community has underestimated Zuma. Repeatedly, he’s fought back ruthlessly. He doesn’t conform to the “usual rules” or the same political calculations. He cares only about his interests and those of his sponsors and of a band of ‘comprador’ nationalists.</p>
<p>Zuma plunged his knife into Gordhan’s back with ruthlessness but also cowardice: he didn’t even have the decency to look his former comrade in the struggle, in the eye.</p>
<p>Democratic leaders don’t fire their finance ministers late at night, without even having the grace to contact the person being removed from office or without some kind of press conference. Close to midnight, the presidency published <a href="http://www.iol.co.za/news/politics/zuma-names-10-new-ministers-10-new-deputies-8424900">the list </a> of 20 new ministers and deputy ministers, while Zuma slipped away into the dark and onto his presidential jet to Durban.</p>
<p>There have been many other notorious “<a href="http://www.historylearningsite.co.uk/nazi-germany/the-night-of-the-long-knives/">nights of the long knives</a>”. Now Africa’s <a href="https://theconversation.com/south-africa-is-africas-largest-economy-again-but-what-does-it-mean-63860">biggest economy</a> has its own contribution to offer the annals of political history. Caused by a crisis in political leadership, Zuma’s ruthless display of power could prompt an economic crisis that could easily send South Africa into a <a href="https://www.bloomberg.com/politics/articles/2016-12-23/2016-was-awful-for-brazilians-and-2017-doesn-t-look-much-better">Brazil-style downward spiral</a> whose consequences are impossible to predict.</p><img src="https://counter.theconversation.com/content/75550/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Calland is a partner of The Paternoster Group and a Board member of the Open Democracy Advice Centre and a member of the Advisory Council of the Council for the Advancement of the South African Constitution. </span></em></p>The focus will now be on how the social democratic and left-leaning members of South Africa’s cabinet – the “constitutionalists” – will respond to the reshuffle.Richard Calland, Associate Professor in Public Law, University of Cape TownLicensed as Creative Commons – attribution, no derivatives.