tag:theconversation.com,2011:/us/topics/rating-agencies-28825/articlesrating agencies – The Conversation2022-02-13T07:14:21Ztag:theconversation.com,2011:article/1768272022-02-13T07:14:21Z2022-02-13T07:14:21ZMoody’s has bought a leading African rating agency: why it’s bad news<figure><img src="https://images.theconversation.com/files/445887/original/file-20220211-23-zg02tz.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">EMMANUEL DUNAND/AFP/Getty Images</span></span></figcaption></figure><p>Moody’s Investors Service, one of the three dominant global credit rating agencies, <a href="https://www.news24.com/fin24/companies/why-moodys-is-buying-africas-largest-ratings-agency-20220202">is acquiring</a> a majority shareholding in Global Credit Rating (GCR), a leading credit rating agency in Africa. </p>
<p>The move is based on Moody’s anticipation that there will be a robust increase in demand for credit rating services in Africa. Moody’s also has a <a href="https://merisratings.com/#page-127">significant stake</a> in the Egypt-based Middle East Rating and Investors Service or MERIS. </p>
<p>Credit ratings agencies are key players in financial markets. They provide a quantified assessment of the creditworthiness of a borrower. In Africa, the demand for borrowing through financial markets is growing exponentially as traditional <a href="https://www.un.org/africarenewal/magazine/august-november-2017/alternative-financing-strategies-boost-small-businesses-africa">funding sources dry up</a></p>
<p><a href="https://gcrratings.com/">GCR</a> is the largest rating agency headquartered in Africa. It accounts for most of the ratings issued on the continent. It was established in 1996 and is based in Mauritius, with offices in South Africa, Nigeria, Kenya and Senegal. </p>
<p>The ‘big three’ rating agencies – Moody’s, S&P Global Ratings and Fitch – control more than 95% of the global credit rating business. They have been accused of monopolising the credit rating market by implementing anti-competition tactics to maintain their market dominance. In the US and Europe, <a href="https://www.govinfo.gov/content/pkg/CHRG-110hhrg51103/html/CHRG-110hhrg51103.htm">they were fined for anti-competition practices</a>. </p>
<p>Other shortcomings include a lack of understanding of the domestic context of African economies. This is because their primary analysts barely conduct field visits in rated countries. Moody’s only has one office in South Africa which covers all the <a href="https://tradingeconomics.com/country-list/rating?continent=africa">28 African countries</a> that it assigns ratings.</p>
<p>Having an increased presence in Africa will certainly enhance Moody’s understanding of the local context in rated countries. Nevertheless, its acquisitions are a huge setback for the development of alternative rating agencies to compete against the monopoly of the ‘big three’.</p>
<h2>Home-grown capabilities</h2>
<p>GCR has pioneered the ratings of domestic instruments that were aligned with Africa’s long-term strategy for promoting access to affordable capital and promoting the development of domestic financial markets. An example is an <a href="https://www.uneca.org/?q=private-sector-development-and-finance">innovative financing initiative</a> that’s supporting governments to mobilise domestic resources through domestic financial markets. It’s been supported by the African Union and United Nations Economic Commission for Africa.</p>
<p>African-based rating agencies mainly assign ratings for domestic issuances. Their ratings are more detailed and significantly higher than both international ratings issued by the ‘big three’. This is because they understand the local contexts and that domestic borrowings have no exposures to exchange rate risk. </p>
<p>The danger is that Moody’s entrance into the domestic ratings market ushers in the challenge of negative analyst biases against African countries. This trend has been visible in the <a href="https://www.dw.com/en/africa-imf-bias-discrimination-debt-international-investors/a-54564359">international ratings market</a>. </p>
<p>There is also a problem of regulation when it comes to international rating agencies operating on the continent. They are largely <a href="https://theconversation.com/african-countries-need-to-manage-the-rising-power-of-credit-rating-agencies-109594">unregulated</a>. Most rated African countries have domestic bond markets. But they lack legislation for credit rating services. In addition, they do not have competent authorities to oversee the regulation and licensing of international rating agencies.</p>
<p>The exception is South Africa which has the G20 comparable laws requiring international rating agencies to be registered and licensed locally. They are also required to operate within the country’s credit rating services regulations.</p>
<p>Without competent authorities that enforce regulations in each country, there is no central coordination to keep the work of international rating agencies under check. </p>
<p>This is true too when it comes to the issue of anti-competitive behaviour. In a well regulated environment, Moody’s acquisition of GCR would have been assessed on the basis of anti-competitive considerations. </p>
<h2>Moody’s failures</h2>
<p>Moody’s has been <a href="https://www.bloomberg.com/news/articles/2015-09-28/zambia-tells-investors-to-ignore-unsolicited-moody-s-downgrade">called out</a> for issuing unsolicited credit ratings. These are sovereign ratings that are assigned without being requested by either the rated country or its agents. Effectively, the rated country does not have any formal contractual relationship with the rating agency. So it’s not paid for. </p>
<p>Among the ‘big three’, Moody’s has the highest number of countries it assigned unsolicited ratings. </p>
<p>There are a number of downsides to unsolicited ratings. Firstly, the rating agency does not consult adequately with government representatives during the review process. This means it doesn’t gain an understanding of the sovereign risk exposures and the government’s strategy in addressing the downside risk factors. </p>
<p>Secondly, the lack of an agreement with the country being rated opens the door to rating agencies using unfavourable unsolicited ratings as a <a href="https://academic.oup.com/rfs/article-abstract/27/2/484/1581201?redirectedFrom=fulltext">credible ‘threat’</a>, forcing countries into contracts.</p>
<p>Over and above the issue of unsolicited ratings, a number of African countries have registered their displeasure with credit ratings, especially from Moody’s. Media statements have been issued advising stakeholders that the ratings aren’t reflective of the countries’ creditworthiness. In some instances, countries have appealed the ratings.</p>
<p>Examples include:</p>
<ul>
<li><p>The Zambian government <a href="https://www.bloomberg.com/news/articles/2015-09-28/zambia-tells-investors-to-ignore-unsolicited-moody-s-downgrade">rejecting</a> Moody’s rating downgrade in 2015;</p></li>
<li><p>The Namibian Government <a href="https://www.reuters.com/article/namibia-ratings-idAFL5N1KZ0GD">appealed Moody’s downgrade</a> of the country to junk status in 2017;</p></li>
<li><p>Nigeria strongly contested Moody’s downgrade in both <a href="https://allafrica.com/stories/201711090049.html">2016 and 2017</a>;</p></li>
<li><p>Tanzania <a href="https://www.reuters.com/article/tanzania-ratings/tanzania-criticises-moodys-for-negative-rating-outlook-idUSL5N1QN4U8">appealed against Moody’s</a> inaccurate rating in 2018;</p></li>
<li><p>Ghana recently <a href="https://africa.businessinsider.com/local/markets/ghana-accuses-moodys-of-bias-after-its-credit-rating-was-downgraded-by-the-ratings/bbbf14p">appealed against</a> its rating by Fitch and Moody’s, which is not reflective of the country’s risk factors.</p></li>
</ul>
<p>No country has successfully appealed a decision. This is for a number of reasons. Firstly, there is no appeal authority on the continent that can conduct a fair hearing of the country’s submissions and pronounce a decision. Instead the appeals are in accordance with the agency’s own rules provided under the <a href="https://www.sec.gov/Archives/edgar/data/1698547/000119312519091962/d721318dex99e2nrsro.pdf">Procedures and Methodologies Used to Determine Credit Ratings</a>. </p>
<p>Secondly, the rating agencies are both ‘the player and referee in Africa’. This is not the case in other <a href="https://www.esma.europa.eu/press-news/esma-news/esma-finds-high-level-divergence-in-disclosure-esg-factors-in-credit-ratings">territories</a>.</p>
<h2>Solutions</h2>
<p>There is a growing appetite for African-issued financial instruments. An indication of this is bond issuances being <a href="https://theconversation.com/african-governments-have-developed-a-taste-for-eurobonds-why-its-dangerous-165469">oversubscribed by at least three times</a>. This has resulted in rating agencies positioning themselves for more business on the continent. </p>
<p>As their dominance and influence continues to expand through mergers and takeovers, African countries need to consider taking the following steps.</p>
<p>First, enact legislation on credit rating services to ensure that regulation of international credit rating agencies is at least on a par with international requirements. They should be in line with the G20 requirement of regulated and accountable credit rating agencies at a global level.</p>
<p>Second, competent authorities responsible for enforcing the credit rating services legislation, should be mandated to issue rules and guidelines to provide additional guidance and ensure uniform implementation of the laws.</p>
<p>In addition, the African Union and its agencies should coordinate national competent authorities to institute a continental regulatory body as a platform of appeal for countries that seek recourse from the unfair practices by rating agencies. This should be an equivalent of the <a href="https://www.esma.europa.eu/about-esma/esma-in-short/complaints">European Securities and Markets Authority</a> and the <a href="https://www.sec.gov/page/ocr-section-landing%E2%80%8B">US Securities and Exchange Commission</a></p>
<p>Without these, African countries will continue to face the challenges of unsustainable borrowing in both domestic and international markets.</p><img src="https://counter.theconversation.com/content/176827/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Misheck Mutize is the Lead Expert researcher with the African Union - African Peer Review Mechanism (APRM) on supporting countries on their engagements with international credit rating agencies.
</span></em></p>Moody’s acquisitions are a setback for the development of alternative rating agencies to compete against the monopoly of the ‘big three’.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/1571512021-03-17T15:08:10Z2021-03-17T15:08:10ZWhy, 31 years after independence, Namibians aren’t in a festive mood<figure><img src="https://images.theconversation.com/files/390150/original/file-20210317-13-fqjs2b.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Hundreds of Namibians protested against growing gender-based violence in October 2020. The Afrikaans wording on the placard says 'We are tired'. </span> <span class="attribution"><span class="source">Hildegard Titus/AFPvia Getty Images)</span></span></figcaption></figure><p>Namibia celebrates its 31st independence day <a href="https://www.sahistory.org.za/dated-event/namibia-gains-independence">this month</a>. But Namibians are not in a festive mood. A <a href="http://www.afrobarometer.org/press/trust-political-institutions-decline-namibia-afrobarometer-survey-shows">2019 survey</a> by Afrobarometer, the independent African research network, showed a significant loss of trust in the country’s governance. </p>
<p>Worse: 2020 became <a href="https://ippr.org.na/publication/namibia-qer-quarter-4-2020/">“a year like no other”</a>
since independence in 1990, as the COVID-19 pandemic compounded the effects of a prolonged recession <a href="https://www.namibian.com.na/159400/archive-read/Namibia-goes-into-technical-recession">which began in 2016</a>.</p>
<p>The legitimacy of the former liberation movement, the South West Africa People’s Organisation (<a href="http://www.swapoparty.org/history.html">SWAPO</a>), has steadily been eroded due to a combination of factors. These have included socioeconomic decline, SWAPO’s increasingly outdated populist narrative, financial scandals and elite self-enrichment. In addition, opposition has grown in the form of electoral support for new parties. </p>
<p>After independence from South Africa <a href="https://muse.jhu.edu/article/434032">in 1990</a> it won elections by huge <a href="http://www.tfd.org.tw/export/sites/tfd/files/publication/journal/155-173-How-Democratic-Is-Namibias-Democracy.pdf">margins</a>, enabling it to entrench its power. Like other <a href="https://theconversation.com/how-liberators-turn-into-oppressors-a-study-of-southern-african-states-57213">former liberation movements</a>, its legitimacy centred on the idea that citizens owed the party unconditional loyalty in return for liberation. </p>
<p>But heroic narratives tend to have a sell by date. Since 2015 it’s become increasingly clear that SWAPO has lost appeal among the <a href="https://www.namibian.com.na/60296/archive-read/Born-free-and-in-search-of-political-answers">younger generation</a> as the struggle for liberation passes into history. This generation expects good governance and measures it not in rhetoric but in delivery. After all, they were born into an independent state. Their number as voters is about to become a majority. </p>
<h2>Downward spiral</h2>
<p>The election results of 2019 and 2020 indicated the decline in support for the erstwhile liberation movement.</p>
<p>The National Assembly and presidential elections <a href="https://namibian-studies.com/index.php/JNS/article/view/8638">in November 2019</a> marked a turning point. SWAPO’s National Assembly votes dropped from 80% in 2014 to now 66%. For the first time since 1995, it no longer holds a two-thirds majority. Beneficiaries were the official opposition <a href="https://www.facebook.com/pg/OfficialOppositionNamibia/posts/">Popular Democratic Movement</a> and the new <a href="https://www.lpmparty.org/">Landless People’s Movement</a>, which came third. </p>
<p>President Hage Geingob was re-elected for a second (and last) term with only 57% of the vote (2014: 87%). His votes were snatched by <a href="https://www.facebook.com/DrItula/">Panduleni Itula</a>, a party rival posing as an independent candidate. He personified the internal party power struggles. After being expelled, he founded his own party, the <a href="https://www.facebook.com/ipcpatriots/">Independent Patriots for Change</a>. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/namibias-democracy-enters-new-era-as-ruling-swapo-continues-to-lose-its-lustre-151238">Namibia's democracy enters new era as ruling Swapo continues to lose its lustre</a>
</strong>
</em>
</p>
<hr>
<p>The November 2020 <a href="http://democracyinafrica.org/democracy-beyond-swapo-in-namibia/">elections</a> for the regional and local authorities shifted the ground further. In the <a href="https://ippr.org.na/blog/the-changing-political-landscape/">changing political landscape</a> only SWAPO’s traditional stronghold in the northern region suffered limited damage. The results everywhere else were disastrous.</p>
<p>On average, SWAPOs’ aggregate votes in all regions dropped from 83% in 2015 to 57%. In the 57 local authorities the party won only 40% of all votes (2015: 73%). It maintained control over just 20 of the 52 local councils it previously held.</p>
<p>Most urban centres, including the capital Windhoek, were seized by other parties or coalitions. Main winners were the Independent Patriots for Change and the Landless People’s Movement. Notably, the Popular Democratic Movement could not improve its scores significantly.</p>
<h1>Economy on the rocks</h1>
<p>Namibia recorded annual economic growth rates of up to <a href="https://countryeconomy.com/gdp/namibia">6% until 2015</a>. But the global economic crises and the ailing neighbouring economies of Angola and South Africa, in combination with a lasting drought, created severe setbacks. Since 2016 Namibia has been in <a href="https://www.namibian.com.na/159400/archive-read/Namibia-goes-into-technical-recession">recession</a>. </p>
<p>The World Bank has Namibia classified as a <a href="https://www.worldbank.org/en/country/namibia/overview">upper middle-income</a> country. The annual <a href="https://tradingeconomics.com/namibia/gdp-per-capita">average per capita income</a> peaked at US$ 6,274 in 2015 and dropped to US$ 5,766 in 2019. This contrasts – despite the crisis – favourably <a href="https://data.worldbank.org/indicator/NY.GDP.PCAP.CD?locations=ZG">with US$ 1,596 in 2019 for sub-Saharan Africa in general</a>.</p>
<p>But the relative wealth is anything but fairly distributed. Inequality remains at staggering proportions. According to the latest United Nations Human Development Report, over half of employed Namibians earn <a href="https://www.namibiansun.com/news/over-half-of-namibians-earn-less-than-n1-400-report2021-03-01">less than US$95 (N$ 1,400) a month</a>. Even among those in paid employment this amounts to less than the average per capita income for sub-Saharan Africa.</p>
<p>The full effect of the COVID-19 pandemic on <a href="https://www.namibian.com.na/207841/archive-read/Over-12-000-workers-retrenched-in-2020">rising unemployment</a> remains to be seen. Public debt has risen to over <a href="https://www.namibiansun.com/news/govt-debt-rises-to-n117bn2020-05-27/">two-thirds of GDP</a>. The economy contracted by an estimated 8% in 2020 and regressed to <a href="https://www.namibian.com.na/94491/read/Economy-to-slump-back-to-2013-levels">2013 levels</a>. Economists assume that a <a href="https://www.republikein.com.na/nuus/tough-decades-ahead-for-nam2020-11-05">return to the 2015 level</a> won’t be achieved before 2024. </p>
<p>Credit rating agency Moody’s <a href="https://allafrica.com/stories/201708140763.html">downgraded</a> Namibia to “junk status” in August 2017. It has negatively <a href="https://www.namibiansun.com/news/more-junk-from-moodys2020-12-07">adjusted</a> Namibia’s status since then, most recently in December 2020, to three notches below junk. A further downgrade <a href="https://informante.web.na/?p=302250">looms</a>.</p>
<h1>Corruption</h1>
<p>Namibia was rocked by a <a href="https://www.occrp.org/en/investigations/sidebar/the-spoils-of-fishrot-tracking-the-property-holdings-of-key-figures-in-namibias-biggest-bribery-scandal">bribery scandal</a> over fishing quotas in November 2019. The <a href="https://www.aljazeera.com/news/2019/12/1/exclusive-corruption-in-namibias-fishing-industry-unveiled">#fishrot</a> scandal implicated two ministers and leading officials of state-owned enterprises. They are awaiting trial in prison. Evidence suggests that other leading party members are also implicated.</p>
<p>Instead of tackling the issue head on, President Geingob decided on an evasive approach. He declared 2020 a <a href="https://www.namibian.com.na/196809/archive-read/The-Year-of-Introspection">“year of introspection”</a>. But an increasingly infuriated public witnessed further cover-ups and denialism. </p>
<p>The government commissioned an internal report into shady deals by the state-owned diamond trading company <a href="https://www.namdia.com/">Namdia</a>, but its contents have <a href="https://www.namibiansun.com/news/president-parks-namdia-report2021-01-22">not been disclosed</a> since it was submitted to Geingob in 2018. </p>
<p>Another state-owned enterprise, <a href="http://www.airnamibia.com/">Air Namibia</a>, became a showpiece of mismanagement, using up enormous state subsidies and bailouts while <a href="https://www.namibian.com.na/99425/read/Scale-of-AirNams-debts-revealed-in-liquidation">amassing liabilities</a>. It was eventually <a href="https://www.africanews.com/2021/02/11/pressed-by-losses-and-debt-namibia-s-national-airline-folds//">liquidated</a> in February 2021.</p>
<h2>Battle for legitimacy</h2>
<p>As the election results of 2019 and 2020 show, even a dominant party regime needs to use its authority and space to show that it serves the interest of the people. If people feel <a href="https://theconversation.com/southern-africas-former-liberators-offer-rich-lessons-in-political-populism-70490">neglected</a>, their loyalty will decline. </p>
<p>Other parties also have to earn legitimacy and show that they are not more of the same. </p>
<p>The Popular Democratic Movement as the official parliamentary opposition party has not gained from SWAPO’s decline in the November 2020 elections. Instead, two new parties – the Landless People’s Movement and the Independent Patriots for Change – are setting the tune. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/southern-africas-former-liberators-offer-rich-lessons-in-political-populism-70490">Southern Africa's former liberators offer rich lessons in political populism</a>
</strong>
</em>
</p>
<hr>
<p><a href="https://www.namibiansun.com/news/intra-party-cracks-widen-in-opposition2021-03-12/">In-fighting</a> rages in all parties of political influence. Whether it’s a sign of decline among the established parties or one of ascendancy among the new kids ones, the fight over their future seems in full swing. </p>
<p>New dynamics suggest that the political culture is damaged. Parliament has seen <a href="https://futuremedia.com.na/chaos-in-national-assembly/">physical contests</a>, insults and <a href="https://twitter.com/KalondoMonica/status/1370295633748373505">sexist remarks</a>.</p>
<h2>Lingering question</h2>
<p>Days before Namibia’s independence on 21 March 1990, a poem on a wall in what used to be a compound for contract labour asked: </p>
<blockquote>
<p>Now that the Namib sings</p>
<p>And the tear of the Katatura child washed away</p>
<p>Who will keep the fire burning?</p>
</blockquote>
<p>After 31 years of independence, the answer remains pending.</p><img src="https://counter.theconversation.com/content/157151/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Henning Melber has been a member of the South West Africa People’s Organisation (SWAPO) since 1974. </span></em></p>The legitimacy of SWAPO, the former liberation movement that has governed since 1990, has been eroded amid growing corruption and a deepening economic crisis.Henning Melber, Extraordinary Professor, Department of Political Sciences, University of PretoriaLicensed 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/1368632020-04-30T12:25:28Z2020-04-30T12:25:28ZWhy downgrading countries in a time of crisis is an exceptionally bad idea<figure><img src="https://images.theconversation.com/files/331371/original/file-20200429-51495-5e3t30.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The street market at Mont-Bouët in Libreville, Gabon. The country was one of 10 on the continent downgraded this year.</span> <span class="attribution"><span class="source">Getty Images</span></span></figcaption></figure><p>A number of rating agencies have downgraded emerging market economies during the COVID-19 pandemic. Their actions have raised the question: <a href="https://www.dailymaverick.co.za/article/2020-04-06-fitch-downgrade-pours-more-salt-into-the-gaping-wound-that-is-the-sa-economy/">why</a> <a href="https://www.bloomberg.com/news/articles/2020-04-03/a-trio-of-downgrades-spell-default-danger-for-emerging-markets">do so</a> during a crisis? </p>
<p>This is not the first time ratings agencies have adopted a procyclical approach – that is, one in which bad news is simply piled on bad news.</p>
<p>During the 2008 global financial crisis, ratings agencies were accused of aggressively <a href="https://www.cfr.org/backgrounder/credit-rating-controversy">downgrading countries</a> whose economies were already strained. Reports by the <a href="https://ec.europa.eu/economy_finance/publications/external_publishers/ex_pub3_en.htm">European</a> and <a href="https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf">US</a> Commissions found evidence that their decisions worsened the financial crisis.</p>
<p>Nobel laureate Joseph Stiglitz has also <a href="https://academiccommons.columbia.edu/doi/10.7916/D8QF93PN">accused rating agencies of aggressively downgrading</a> countries during the <a href="https://www.federalreservehistory.org/essays/asian_financial_crisis">1997 East Asian financial crisis</a>. The downgrades were more than what would be justified by the countries’ economic fundamentals. This unduly added to the cost of borrowing and caused the supply of international capital to evaporate.</p>
<p>In addition to the issue of timing, the <a href="https://www.cdhowe.org/sites/default/files/attachments/research_papers/mixed/Commentary_356.pdf">effectiveness</a> and <a href="https://ukdiss.com/examples/problems-of-the-credit-rating-agencies.php">objectivity</a> of the rating methodology continues to be questioned by <a href="https://www.adb.org/sites/default/files/publication/156043/adbi-wp188.pdf">policymakers</a>. Their methodological errors in <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2349003">times of crisis</a>, together with the unresolved problem of <a href="https://theconversation.com/why-credit-rating-agencies-are-still-getting-away-with-bad-behaviour-117549">conflict of interests</a>, leave both issuers and investors vulnerable to losses. </p>
<p>The procyclical nature of ratings needs to be put under check to avoid market panic. The devastating effects they add on economies that are already strained has to be challenged. The coronavirus pandemic is yet another episode to prove this.</p>
<h2>Questionable decisions</h2>
<p>Ten African countries have been downgraded since the COVID-19 pandemic started – Angola, Botswana, Cameroon, Cape Verde, Democratic Republic of the Congo, Gabon, Nigeria, South Africa, Mauritius and Zambia.</p>
<p>These decisions were based on <a href="https://www.ispionline.it/en/pubblicazione/coronavirus-will-hit-africa-hard-25716">expectations</a> that their fiscal situations would deteriorate and their <a href="https://www.theafricareport.com/24952/africa-faces-a-coronavirus-catastrophe/">health systems</a> would be severely strained by the pandemic. </p>
<p>But, in my view, the downgrade decisions reflect monumental bad timing. I would also argue that, in most cases, they were premature and unjustified.</p>
<p>Since international rating agencies have tremendous power to influence market expectations and investors’ portfolio allocation decisions, crisis-induced downgrades undermine macroeconomic fundamentals. Once downgraded, like a self-fulfilling prophecy, even countries with strong macroeconomic fundamentals deteriorate to converge with model-predicted ratings. Investors respond by raising the cost of borrowing or by withdrawing their capital, aggravating a crisis situation.</p>
<ul>
<li><p>South Africa was <a href="https://www.moodys.com/research/Moodys-downgrades-South-Africas-ratings-to-Ba1-maintains-negative-outlook--PR_420630">stripped</a> of its last investment grade by Moody’s. The rating agency cited a rising debt burden of 62.2%, which was estimated to reach 91% of GDP by fiscal 2023; and structurally weak growth of less than 1%, which was estimated to shrink to <a href="https://www.imf.org/en/Publications/WEO/Issues/2020/04/14/weo-april-2020">-5.8%</a>. It was hoped that Moody’s would <a href="https://www.fin24.com/Economy/South-Africa/could-coronavirus-give-sa-another-breather-from-moodys-junk-status-20200326">delay its rating action</a> to see the impact of the coronavirus onshore and the country’s policy responses. The procyclical effect of the downgrade magnified the impact of the lockdown. Fitch further pushed it <a href="https://www.fitchratings.com/research/islamic-finance/fitch-downgrades-south-africa-to-bb-outlook-negative-03-04-2020">deep into junk</a> a week later. </p></li>
<li><p>Fitch cut Gabon’s sovereign rating to CCC from B on <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/fitch-downgrades-gabon-to-ccc-on-debt-repayment-risks-57907795">3 April 2020</a>. The rationale for the downgrade was that agencies expected the risks to sovereign debt repayment capacity to increase due to liquidity pressure from the fall in oil prices.</p></li>
<li><p>Moody’s revised Mauritius’s sovereign rating outlook from Baa1 stable to negative on <a href="https://www.moodys.com/research/Moodys-changes-the-outlook-on-Mauritiuss-rating-to-negative-from--PR_420034">1 April 2020</a>. Moody’s said the downgrade was driven by the expectation of lower tourist arrivals and earnings due to the coronavirus. Both would have a negative impact on the country’s economic growth.</p></li>
<li><p>Nigeria was downgraded by S&P from B to B- on <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/fitch-downgrades-nigeria-amid-oil-price-slump-pandemic-shock-57921342">26 March 2020</a>. The reason was that COVID-19 had added to the risk of fiscal and external shock resulting from lower oil prices and economic recession. Yet the investment grades of Saudi Arabia and Russia were spared.</p></li>
<li><p>S&P also downgraded Botswana – one of the most <a href="https://www.bbc.com/news/world-africa-13040376">stable economies in Africa</a> – which had an A rating. The agency <a href="https://www.diamonds.net/News/NewsItem.aspx?ArticleID=64900&ArticleTitle=Market+Slump+Prompts+Botswana+Downgrade">cited</a> weakening fiscal and external balance sheets due to a drop in demand for commodities and expected economic deceleration because of COVID-19. Botswana’s downgrade came four days after it went into a lockdown and <a href="https://www.voanews.com/science-health/coronavirus-outbreak/botswana-no-covid-19-cases-closes-borders-after-death-zimbabwe">before it had recorded a confirmed</a> case of COVID-19. </p></li>
</ul>
<p>These downgrades deep into junk impose a wave of <a href="https://www.bloomberg.com/news/articles/2020-04-03/a-trio-of-downgrades-spell-default-danger-for-emerging-markets">other problems</a>, worse than COVID-19. They cut sovereign bond value as collateral in central bank funding operations and drive interest rates high. Sovereign bond values are grossly discounted, at the same time escalating the cost of interest repayment instalments, ultimately contributing to a rise in the cost of debt. A wave of corporate downgrades also follows because of the sovereign ceiling concept – a country’s rating generally dictates the highest rating assigned to companies within its borders.</p>
<h2>Solution</h2>
<p>In response to the procyclical COVID-19 induced downgrades, African countries need to implement these four measures. </p>
<p>First, to curb the procyclical nature of rating actions that disrupt markets by triggering market panic, the timing of rating announcements needs to be regulated. Regulators of rating agencies such as the <a href="https://www.fsca.co.za/Pages/Default.aspx">Financial Sector Conduct Authority</a> in South Africa have the power to determine the timing of rating. In times of crisis, rating agencies should defer publishing their rating reviews as markets have their way of discounting risk when fundamentals are conspicuously changing. </p>
<p>Second, the rules of disclosure and transparency should be enhanced during rating reviews. Rating methodologies, descriptions of models and key rating assumptions should be disclosed to enable investors to perform their own due diligence to reach their own conclusions.</p>
<p>Third, in collaboration with other market regulatory bodies in the financial markets, transactions that unfairly benefit from crisis-driven price falls should be restricted. This includes short-selling of securities – a market strategy that allows investors to profit from securities when their value goes down.</p>
<p>Lastly, African countries need to develop the capacity for rigorous engagement with rating agencies during rating reviews and appeals. They need to make sure that the agencies have all the information required to make a fair assessment of their rating profiles.</p>
<p>The African Union and its policy organs need to fast track the adoption of its continental policy framework of mechanisms on rating agencies’ support for countries. This will assist them to manage the practices of rating agencies.</p><img src="https://counter.theconversation.com/content/136863/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Misheck Mutize consults for the African Peer Review Mechanism (APRM) on support to African Union (AU) member states on credit rating agencies.</span></em></p>Downgrades have a devastating effect on economies that are already strained. The decision to downgrade during a crisis like the coronavirus pandemic must be challenged.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/1175492019-06-23T08:05:50Z2019-06-23T08:05:50ZWhy credit rating agencies are still getting away with bad behaviour<figure><img src="https://images.theconversation.com/files/280666/original/file-20190621-61771-1vkx70o.jpg?ixlib=rb-1.1.0&rect=359%2C0%2C4940%2C3988&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Rating agencies have been at the centre of major financial crises</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>International credit rating agencies have had their fair share of <a href="https://www.cfr.org/backgrounder/credit-rating-controversy">controversies</a> over the years. They have been at the centre of the major financial crises from the financial markets collapse of <a href="https://digital.lib.washington.edu/researchworks/bitstream/handle/1773/40208/Reagan_washington_0250E_17396.pdf?sequence=1&isAllowed=y">New York City in the mid-1970s</a>, the <a href="https://mpra.ub.uni-muenchen.de/36469/2/MPRA_paper_36469.pdf">Asian financial crisis</a> of 1997 – 1998, the <a href="https://www.nytimes.com/2001/11/29/business/enron-s-collapse-rating-agencies-debt-rankings-finally-fizzle-but-deal-fizzled.html">Enron scandal</a> of 2001, to the <a href="https://truthout.org/articles/the-indisputable-role-of-credit-ratings-agencies-in-the-2008-collapse-and-why-nothing-has-changed/">global financial crisis of 2008</a>. All of these cost investors globally billions. </p>
<p>Rating agencies are meant to give comfort about an issuer’s ability to repay debt. Ratings are essential in determining the level of interest rate that a borrower must pay. Inaccurate ratings therefore distort both the prices of debt instruments and the interest rates payable on them. As history has shown, this creates asset bubbles that eventually burst, disrupting the functioning of financial markets.</p>
<p>The three dominant international credit rating agencies – Standard & Poor’s, Moody’s and Fitch – have been accused of many faults including:</p>
<ul>
<li><p><a href="https://www.rt.com/business/421033-sp-credit-agency-lawsuit/">false ratings</a>; </p></li>
<li><p><a href="https://www.dailymaverick.co.za/article/2018-08-28-moodys-to-pay-16-mn-over-flawed-credit-ratings/">flawed methodology</a>; </p></li>
<li><p>encroaching on <a href="https://openaccess.leidenuniv.nl/bitstream/handle/1887/54340/2016_Luten_PA_IEG.pdf?sequence=1">government policy</a>; </p></li>
<li><p>political <a href="https://journals.sagepub.com/doi/abs/10.1177/0010414017710263">bias</a>, </p></li>
<li><p><a href="https://erf.org.eg/wp-content/uploads/2018/02/Abdullah-Yalta.pdf">selective aggression</a>;</p></li>
<li><p>and <a href="https://www.ft.com/content/852a0672-3904-11e4-9cce-00144feabdc0">rating shopping</a>. </p></li>
</ul>
<p>These shortcomings originate from their ‘issuer-pay’ business model. The institution being rated pays for the rating which is used by investors. This means that the model has an inherent conflict of interest. </p>
<p>Although this has been evident through various crises – most notably the financial meltdown in 2008 – regulatory mechanisms are yet to address this problem. And, despite these known weaknesses, rating agencies are still being referenced in key financial market decisions.</p>
<h2>Why current regulations aren’t working</h2>
<p>A <a href="https://www.researchgate.net/publication/228203856_The_Issuer-Pays_Rating_Model_and_Ratings_Inflation_Evidence_from_Corporate_Credit_Ratings">number of studies</a> have identified the issuer-pay revenue model as a key driver of conflict of interest. Here are four reasons why I think the current attempts to regulate ratings agencies will not address conflict of interest.</p>
<p>The first big problem is the relationship between the rating agencies and the issuers. This relationship naturally creates pressure for both the lead rating analyst – around which the whole <a href="https://www.moodys.com/sites/products/ProductAttachments/mis_ratings_process.pdf">rating process</a> is centred – and the ratings committee to give favourable ratings over time. </p>
<p>This is how the process works: after an issuer contracts a rating agency, the ratings agency assigns an analytical team (lead and support analysts) to gather information about the entity from different sources they deem credible. The analytical team makes recommendations to a ratings committee, convened by the lead analyst. The lead analyst also <a href="https://www.moodys.com/sites/products/ProductAttachments/mis_ratings_process.pdf">determines</a> the size and composition of the ratings committee based on the size and the complexity of the credit analysis. </p>
<p>The second problem is that rating agencies are bound to be concerned about the sustainability of their revenue sources because they’re profit driven businesses. They will fight to protect their income at the expense of aggressive or objective ratings that could compromise revenues, although in the long-run will damage their businesses. </p>
<p>The third problem is that the individual employees of a rating agency face no <a href="https://www.jstor.org/stable/23074028?seq=1#metadata_info_tab_contents">criminal liability</a>. Conflict of interest usually manifests itself through members of the analytical team.</p>
<p>Lastly, the credit ratings industry is highly concentrated. Moody’s Investors Service and Standard & Poor’s together control 80% of the global rating market. Fitch Ratings accounts for a further 15%. The ‘big three’ credit rating firms seek to maintain dominance in the industry through discouraging any <a href="https://www.livemint.com/opinion/online-views/opinion-rotation-of-credit-rating-agencies-must-be-avoided-1556058549186.html">activities</a> that may lead to a loss in their market share. They are unwilling to <a href="https://hbswk.hbs.edu/item/why-competition-may-not-improve-credit-rating-agencies">allow competition</a>, suggesting that it could instead lead to poor ratings. </p>
<h2>Responses</h2>
<p>Following the 2008 Global Financial crisis the <a href="https://www.sec.gov/news/press-release/2017-238">US</a>, <a href="https://ec.europa.eu/info/law/credit-rating-agencies-regulation-ec-no-1060-2009_en">European Union</a>, <a href="http://www.csrc.gov.cn/pub/csrc_en/about/">China</a> and <a href="https://www.fsca.co.za/Regulated%20Entities/Pages/LR-Credit-Ratings.aspx">South Africa</a> introduced legislation to address the flaws in rating agencies’ operations.</p>
<p>Although strict civil laws are necessary to deter misconduct and encourage compliance, enforcing civil regulations only is both an ineffective and expensive way of <a href="https://scholarlycommons.law.northwestern.edu/cgi/viewcontent.cgi?article=7408&context=jclc">curbing conflict of interest</a>. Tighter scrutiny of credit rating agencies by investors, regulators and media is also not effective.</p>
<p>Despite these regulatory responses, rating agencies are still being caught on the wrong side of the law. Recent cases are proof of this. But there’s still the possibility that a great deal of wrongdoings go undetected.</p>
<p>Earlier this year the European Securities and Markets Authority <a href="https://www.esma.europa.eu/press-news/esma-news/esma-fines-fitch-%E2%82%AC5132500-breaches-conflict-interest-requirements">fined</a> the Fitch group of companies in France, Spain and United Kingdom a total of €5 132 000 for failing to maintain independence and avoiding conflict of interest. Fitch UK, Fitch France and Fitch Spain issued ratings on Casino Guichard-Perrachon, Fondation Nationale des Sciences Politiques, and Renault. This was despite the fact that they knew one of their shareholders – which indirectly owned 20% shares in each of the Fitch group companies – was also a board member of the rated companies.</p>
<p>In 2018, China <a href="https://www.bloomberg.com/news/articles/2018-08-20/chinese-rating-company-dagong-issues-apology-after-one-year-ban">suspended licences</a> held by Dagong Global Credit Rating, one of China’s biggest agencies. Dagong was found guilty of submitting false information to regulators and charging borrowers very high fees, actions that regulators said compromised the rating agency’s independence.</p>
<p>In South Africa, the Financial Sector Conduct Authority recently found the <a href="https://gcrratings.com/regulatory-environment/">Global Credit Rating Agency</a> guilty of failure to avoid a conflict of interest. The agency was <a href="https://www.fin24.com/Companies/Financial-Services/hefty-fine-for-credit-rating-agency-over-conflict-of-interest-breach-20190430">fined</a> an administrative penalty of R487 000. The CEO of the GCR undertook to an issuer, whose credit rating had expired, that the GCR would issue a credit rating. This was contrary to the rules that required the CEO to act separately from the agency’s rating analysis team. </p>
<p>At the time of undertaking, the issuer was the process of procuring the services of a rating agency, a process in which global agency was one of the bidders.</p>
<h2>Shortfall in regulatory mechanism</h2>
<p>The continuing infringement by credit rating firms on rules and analysts’ actions that compromise the independence of their opinions shows there is a major shortfall in the current regulatory mechanism.</p>
<p>Although problematic, abandoning the ‘issuer-pay’ business model is not the <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3270894">solution</a> and will push some rating agencies out of business. </p>
<p>The only solution is to criminalise rating misconduct such as breaching conflict of interest. The strict monitoring, scrutiny and penalising of credit rating firms alone will not be enough to deter bad behaviour. Individuals responsible for breach of conflict of interest rules should face criminal prosecution. If this does not happen, analysts will not hesitate to take chances.</p><img src="https://counter.theconversation.com/content/117549/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>Rating agencies continue to be found wanting, primarily because of their business model where the institution being rated pays. This brings about a conflict of interest which is not easy to resolve.Misheck Mutize, Lecturer of Finance, Graduate School of Business (GSB), University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/757172017-04-06T09:20:29Z2017-04-06T09:20:29ZDowngrade: a wake-up call for South Africa to revisit key economic policies<figure><img src="https://images.theconversation.com/files/164251/original/image-20170406-6397-i29ju2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's new Finance Minister Malusi Gigaba.</span> <span class="attribution"><span class="source">Reuters/James Oatway</span></span></figcaption></figure><p>South Africa is digesting the news of Standard & Poor’s (S&Ps) <a href="http://www.fin24.com/Economy/full-statement-sp-cuts-sa-to-junk-status-fears-political-risks-20170403">downgrade</a> of its state debt held in foreign currency following President Jacob Zuma’s March cabinet <a href="https://theconversation.com/stakes-for-south-africas-democracy-are-high-as-zuma-plunges-the-knife-75550">reshuffle</a>. As the country deals with that blow, two other credit rating agencies (Fitch and Moody’s) will soon hold forth. </p>
<p>Even if these agencies’ biases and competence <a href="http://debt-issues.blog.rosalux.de/files/2012/11/Bond-Berlin-paper-on-debt-and-uneven-development-in-contemporary-South-Africa.pdf">should be questioned</a>, it’s likely that further downgrades will lead to a meltdown of the currency.</p>
<p>This scenario would mirror the events of 1985 when then President PW Botha delivered his <a href="https://theconversation.com/south-africa-is-on-a-cliff-edge-just-as-it-was-in-1985-53094">crazed Rubicon Speech which caused</a> a $13 billion default. The foreign debt/GDP ratio hit 40%. Today it is nearly 50%. Botha was compelled to impose exchange controls. </p>
<p>As Zuma goes for broke, the main task ahead for South Africans is to renew the ideological debate over how to protect the currency and kick-start the economy – sensibly and without corruption.</p>
<p>The National Treasury and South African Reserve Bank could initiate a long overdue era of redistribution, racial justice and radical economic transformation. They would need to impose tighter exchange controls to protect the currency, lower interest rates, harness the power of state owned enterprises but without the recent corruption, and increase strategic state spending. </p>
<p>The new Finance Minister Malusi Gigaba <a href="http://ewn.co.za/2017/04/01/finance-minister-malusi-gigaba-radical-transformation">promised</a> to pursue at least one of these at his first press conference after being sworn in. He said that one of his key focus areas would be <a href="https://www.ft.com/content/b7f0766c-16cf-11e7-a53d-df09f373be87">to accelerate “radical economic transformation”</a>. Cynics might point out that he made his comments on April Fool’s Day. </p>
<h2>State owned enterprises</h2>
<p>Similar <a href="http://mg.co.za/article/2014-04-23-soapbox-radical-economic-change-should-be-the-focus-of-this-election">false promises</a> of transformative infrastructure left the country <a href="https://mg.co.za/?article/2014-05-02-soapbox-gigabas-pleasing-infrastructure-promises-soon-to-be-broken-in-durban">disappointed</a> during Gigaba’s role as Minister of State Enterprises between 2010 and 2014. Instead, he bought into the mania for mega-projects which either didn’t work or rewarded carbon-intensive multinational corporations: </p>
<ul>
<li><p>Eskom’s <a href="http://www.dailymaverick.co.za/article/2015-09-29-op-ed-chancellor-house-the-focus-of-hitachis-19m-sec-settlement/#.WAvyusmMSvk">corrupt</a> and <a href="https://www.dailymaverick.co.za/article/2017-04-02-op-ed-eskoms-electricity-surplus-and-self-inflicted-death-spiral/#.WOG3gmclGQw">unnecessary</a> <a href="http://www.fin24.com/Economy/Eskom/water-scarcity-and-pivot-away-from-carbon-riles-medupi-kusile-20160114">Medupi</a> and <a href="https://www.businesslive.co.za/bd/opinion/2016-12-14-cancelling-part-of-kusile-could-save-millions-and-advance-renewables/">Kusile</a> coal-fired power plants. </p></li>
<li><p>Its <a href="http://www.biznews.com/sa-investing/2016/09/23/eskom-unveils-plan-to-pay-for-nuclear-power-plants/">desired</a> R1 trillion in nuclear plants apparently <a href="https://www.businesslive.co.za/rdm/politics/2017-01-18-zuma-the-guptas-and-the-russians--the-inside-story/">pre-contracted</a> (liability-free) from <a href="http://www.news24.com/SouthAfrica/News/russian-nuclear-deal-places-massive-liability-on-south-africans-20170225?">Moscow’s Rosatom</a>. </p></li>
<li><p>Transnet’s climate-frying facilitation of an R800 billion <a href="http://www.mqa.org.za/sites/default/files/Sector%20Skills%20Plan%202015%20-%202016.pdf">plan</a> to export 18 billion tons of coal from Limpopo, Mpumalanga and KwaZulu-Natal and a <a href="https://www.pressreader.com/south-africa/the-mercury/20161114/281754153900981">R250 billion</a> Durban port-petrochemical expansion. </p></li>
<li><p>PetroSA’s R80 billion <a href="http://mg.co.za/article/2011-03-11-mthombo-a-white-elephant-in-the-making">Mthombo refinery</a>.</p></li>
<li><p>World Cup stadiums <a href="http://www.bbc.com/sport/0/football/14348193">now recognised</a> as white elephants after <a href="http://www.reuters.com/article/soccer-leaders-safrica-idUKLDE6951AC20101006">initial assurance</a> they would not be. Thankfully one of Pravin Gordhan’s last acts as Finance Minister was to halt <a href="https://www.dailymaverick.co.za/opinionista/2016-12-05-durban-should-quit-as-commonwealth-games-host-city/">the ridiculous</a> R6.4 billion Durban 2022 Commonwealth Games. </p></li>
</ul>
<p>Sports events aside, these mega-projects are mainly the foibles of state-owned enterprises which S&P singled out on Monday as its second reason – after political hijinks – for the rating <a href="http://www.fin24.com/Economy/full-statement-sp-cuts-sa-to-junk-status-fears-political-risks-20170403">downgrade</a>. </p>
<p>Of <a href="https://theconversation.com/public-enterprises-played-a-big-part-in-south-africas-credit-ratings-downgrade-75745">particular concern</a> are government guarantees used to underwrite public enterprise liabilities which the rating agency forecasts will reach R500bn by 2020. </p>
<p>If instead of mega-projects, Eskom and Transnet built renewable energy and cheap commuter rail transport, for example, radical economic transformation would make South Africa much more sustainable. But that would require a 180-degree turnaround.</p>
<h2>Why South Africa needs exchange controls</h2>
<p>Since Zuma won’t reverse either the cabinet reshuffle or his patronage tendencies, tighter exchange controls are the only way to prevent a debilitating raid on the currency. </p>
<p>Once two rating agencies downgrade South Africa’s local currency debt, the country will be dropped from the Citibank’s World Government Bond Index. As Sygnia’s Magda Wierzycka <a href="https://www.businesslive.co.za/bd/opinion/2017-04-06-will-downgrades-intensify-or-reverse-treasurys-neo-liberal-ideology/">warns</a>:</p>
<blockquote>
<p>If our rand-denominated debt is rated as junk by S&P and Moody’s, South Africa will be dropped from the index. Immediately on that happening, approximately $10-billion, or R137-billion, will flow out of the country.</p>
</blockquote>
<p>That could tempt the South African Reserve Bank to rapidly raise interest rates to protect the rand and restore financial inflows. Higher rates give investors a return needed to offset risk. It has taken drastic action like this before. In 1998 Governor Chris Stals <a href="https://books.google.com/books?isbn=1842773933">raised rates</a> by 7 percentage points within two weeks, as the currency crashed from R7/$ to R10/$. </p>
<p>Instead, a different strategy is needed to deter financial predators and gain the space to lower interest rates: <a href="https://theconversation.com/south-africa-needs-tougher-exchange-controls-before-junk-status-hits-68085">tighter exchange controls</a>. </p>
<p>South Africa already has some in place. Pension funds and other institutional investors must retain 75% of their assets in the domestic market. By <a href="http://www.biznews.com/sa-investing/2016/12/07/exchange-controls-junk/">all accounts</a> this saved South Africa during the last financial meltdown in 2008. </p>
<p>But more controls are needed. Foreign financiers are a fickle group. French bank Societe Generale, for example, recently <a href="http://www.fin24.com/Economy/political-risk-bring-it-on-say-investors-in-sa-debt-20170403#cxrecs_s">increased</a> its rand assets in search of high interest rates. Currently only two countries <a href="http://www.economist.com/indicators">are paying</a> more on 10-year government bonds than South Africa (8.9%) – Venezuela and Brazil.</p>
<p>With rates that high, financial markets are bound to be buoyed by speculative “hot money.” South Africa has the power to stop this from happening. It could, for example, penalise corporations and wealthy residents for taking money out. A similar arrangement, known as the “fin rand” existed between 1985 and 1995.</p>
<h2>Well-directed state spending</h2>
<p>Capitalism’s greatest-ever economist, John Maynard Keynes, <a href="https://www.mtholyoke.edu/acad/intrel/interwar/keynes.htm">insisted</a> that under circumstances of global financial volatility and economic stagnation, not only should exchange controls be imposed. Localised production and greater state spending would be necessary to overcome the private sector’s unwillingness to invest.</p>
<p>The danger everyone recognises, though, is that if Zuma’s new team did abandon fiscal austerity, it would not use additional resources wisely to support economy, society and environment: higher social grants, #FeesMustFall on university tuition, basic-needs infrastructure, reduction of women’s burdens, or a climate justice transition, as a few examples. </p>
<p>In any case, Gigaba has <a href="https://www.bloomberg.com/news/articles/2017-03-31/south-africa-s-gigaba-says-he-will-work-within-fiscal-framework">committed</a> to continuing the austerity drive. He aims to lower the 2019 budget deficit to just 2.6% of GDP: </p>
<blockquote>
<p>I will work within the fiscal framework as agreed by government and parliament. There will not be any reckless decisions.</p>
</blockquote>
<p>The problem for South Africa is that a mild-austerity fiscal framework was tried by Gordhan and failed to restructure the economy or boost growth. </p>
<p>Most neoliberals supporting austerity are expressing schadenfreude – happiness at someone else’s misfortune – because the downgrade is a good stick with which to whip Zuma. They aren’t particularly concerned about economic transformation, poverty or racial inequality.</p>
<p>Nor is Zuma apparently concerned about the economic risks the downgrade has just imposed on all South Africans - his first priority is political survival. </p>
<p>In the days ahead, an ideological debate is desperately needed to sort out society’s options. But the debate would need to transcend the current quagmire caused by both Zuma’s corruption and National Treasury’s capture by the ratings agencies.</p><img src="https://counter.theconversation.com/content/75717/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Patrick Bond 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>An ideological debate is desperately needed to sort out options South Africa could pursue to find a way out of its economic morass.Patrick Bond, Professor of Political Economy, University of the WitwatersrandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/757042017-04-04T11:52:09Z2017-04-04T11:52:09ZWhat a downgrade means for South Africa and what it can do about it<figure><img src="https://images.theconversation.com/files/163792/original/image-20170404-5736-1i9jyhf.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">Justin Lane/EPA</span></span></figcaption></figure><p><em>Rating agency Standard & Poor’s (S&P) has <a href="https://www.bloomberg.com/news/articles/2017-04-03/south-africa-cut-to-junk-first-time-since-2000-after-zuma-purge">cut</a> South Africa’s foreign currency rating to sub-investment grade status. Two other global ratings agencies, Fitch and Moody’s, may well <a href="https://www.enca.com/south-africa/moodys-mulls-over-south-africas-investment-rating">follow suit</a>. The Conversation Africa’s editor Caroline Southey asked Professor Adrian Saville to explain the significance of the decision.</em></p>
<p><strong>How serious is this?</strong></p>
<p>Ratings downgrades are a clear signal to policymakers, investors, business and society more broadly that things are not on track. Although S&P’s decision to downgrade South Africa was only announced on Monday night after President Jacob Zuma’s <a href="http://ewn.co.za/2017/03/31/gordhan-rubbishes-zuma-s-reasons-for-firing-him">disastrous cabinet reshuffle</a>, it’s probably fair to argue that the decision was already in the price and that it has been there for some time.</p>
<p>To substantiate this claim, South African government bond yields have been priced similarly to the likes of <a href="http://www.coronation.com/Assets/za/Personal/Funds/FactsheetComprehensive/2017/February/2017-February-Global-Equity-Select-Fund.pdf">Brazil and Russia</a> for the best part of a year. Indeed, based on economic growth projections alone, South Africa has been failing S&P’s acid test for investment grade status for some time.</p>
<p>If anything, then, the decision to downgrade South Africa is overdue. In the same breath, even though S&P <a href="http://ewn.co.za/2017/04/03/read-the-full-standard-and-poors-statement-south-africa-credit-rating-junk-status">has expressed growing concern</a> about politics getting in the way of policy, strength in institutional fabric and policy consistency has given the country a stay of execution. All of this was put paid to by Zuma’s night of the long knives. </p>
<p>If anything, then, the ratings downgrade is confirmation of what’s been suspected for some time – that South Africa has lost its way from an economic perspective and that the country has also entered the political wilderness. It’s also worth suggesting that there’s a good possibility that S&P’s decision will galvanise the other two ratings agencies into taking a firmer – and less forgiving – stance on South Africa.</p>
<p><strong>What is the real impact going to be on ordinary South Africans, particularly poor people? In the short term and in the medium term.</strong></p>
<p>Arguably the immediate impact will be negligible. The sell-off in the rand, government bonds and banks are felt and seen in capital markets before they spill into the real economy. </p>
<p>But within a month the weaker currency could translate into higher fuel prices at the pump and this will quickly affect household budgets and business margins. </p>
<p>The impact will start to be felt more dramatically in about six months’ time. Exports and imports make up about a third of South Africa’s economic output. Its imports are price inelastic, meaning we take the prices that are given to us. Consequently, about one third of the economy will be subject to the effects of fairly rigid import price inflation. This will take about six months to pass into the economy. A back of the envelope calculation points to consumer price inflation being raised by as much as three percentage points, from a base of, say, 5% to as high as 8% (this is calculated by a rand decline of 10% multiplied by 30% of South African prices being imported). </p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"849118546256949248"}"></div></p>
<p>In the same breath, and perversely, we could also see a near-term boost to some economic segments, especially export-oriented sectors, such as commodity producers and tourism. In time, though, the South African Reserve Bank will be obliged to raise interest rates to deal with higher consumer price inflation. </p>
<p><strong>What other negative economic consequences can the country expect?</strong></p>
<p>From these sequence of events, it follows that, in time, the ratings downgrade is followed by slower economic growth, higher consumer price inflation and higher interest rates. The combination of these factors is called stagflation. This environment is a poor outcome that will hold back economic progress and social transformation. </p>
<p>Of course, it would be naive to argue that this is entirely due to the ratings agencies’ call. Rather, this poor economic outcome was already on the cards. To explain, it’s important to recognise that the ratings agencies don’t have access to more or better information than the market at large and that their calls don’t drive market movements. Rather, their decisions tend to lag rather than lead the markets, and in this way, generally confirm what we already know.</p>
<p><strong>South Africa’s foreign currency debt now has sub-investment grade status, but not its domestic currency debt. Is this significant?</strong></p>
<p>At least two rating agencies must agree on sub-investment grade status and the rating must apply to local currency debt for a country to be ejected from the key <a href="https://www.yieldbook.com/x/ixFactSheet/factsheet_monthly_wgbi.pdf">global government bond index</a>. The sub-investment status attributed to South Africa immediately after the S&P call means that only one agency has rated the country sub-investment grade and this is on foreign currency debt.</p>
<p>This is not to say that the other shoe won’t fall. As things stand, it seems that is only a matter of time before the other agencies join S&P and that the call also extends to include local currency debt. </p>
<p><strong>What remedies could government apply now if it wanted to?</strong></p>
<p>By some measures, South Africa has been off the pace but not in bad shape. The fiscal deficit <a href="http://www.treasury.gov.za/documents/national%20budget/2017/review/FullBR.pdf">stands at</a> about 3.5% of gross domestic product (GDP) and general government debt <a href="http://www.tradingeconomics.com/south-africa/government-debt-to-gdp">is just over</a> 50% of GDP. Neither of these numbers is alarming. Even if we extend the debt net to include all “off balance sheet” obligations – especially via state-owned enterprises – South Africa’s state balance sheet and income statement are still in fair shape.</p>
<p>The real issues are the missing economic growth, entrenched unemployment, hopelessly skewed income distribution and urgently needed industrial invigoration. Under a debt downgrade the ability to repair each of these is compromised. Which means that the challenge rests not just in reestablishing robust policy, but also translating this into practice. </p>
<p>This will require the country to address the veil of uncertainty that shrouds political leadership and that’s left a jaundiced view on decisions that are key to the country’s well being. On this score, the evidence shows that countries that “get the message and get to work” can regain investment grade status fairly quickly – on average about three years. </p>
<p>Those that dither take three times as long – the best part of a decade – to regain investment grade status. Since 2010 Brazil, Croatia, Cyprus, Greece, Hungary, Portugal, Tunisia and Russia have been downgraded to sub-investment grade and none has yet recovered investment grade status. </p>
<p>Critically, a point that should not be lost is that as much as the ratings call is by an external agency, the repair required is domestic, and includes public and private sector facets. For instance, in all cases where countries have regained investment grade status quickly, have displayed two common attributes: The first is high private sector savings rates fuelling high domestic investment levels. The second is sound monetary policy that has been effective in managing the risk of consumer price inflation running away during the recovery.</p>
<p>South Africa has its work cut out for it. The ratings agency decision is not news. It’s a wake-up call.</p><img src="https://counter.theconversation.com/content/75704/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Adrian Saville 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 ratings agency downgrade decision is not a surprise. It’s a wake up call. South Africa has its work cut out.Adrian Saville, Visiting Professor of Economics and Finance, Gordon Institute of Business Science, University of PretoriaLicensed 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/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.tag:theconversation.com,2011:article/698032016-12-05T14:13:49Z2016-12-05T14:13:49ZSouth Africa avoided dreaded junk status. But the economy is far from healthy<figure><img src="https://images.theconversation.com/files/148644/original/image-20161205-19407-1in888w.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The South African economy just narrowly escaped a credit rating downgrade but it is not in the clear yet. </span> <span class="attribution"><span class="source">Reuters</span></span></figcaption></figure><p>The whole economically-aware population of South Africa is celebrating that the three main ratings agencies <a href="http://www.businesslive.co.za/bd/economy/2016-12-05-sa--has-one--year-to-resolve-ratings-issue/">held off</a> on junking the country’s financial reputation in the past two weeks. I am celebrating too. But a closer look is needed.</p>
<p>The <a href="http://www.cnbcafrica.com/news/financial/2016/12/02/sp-sa-long-term-local-currency-ratings/?utm_source=CNBC+Daily+Newsletter&utm_campaign=b04ecc07ab-RSS_EMAIL_CAMPAIGN_Daily&utm_medium=email&utm_term=0_37ea1a8e5e-b04ecc07ab-216204545">statement</a> by Standard & Poors – more strict than Fitch and Moody’s – lacked logic and conviction. Aside from predictable neo-liberal nostrum to cut the budget deficit and reduce labour’s limited influence even further, Standard & Poors neglected some critical economic weaknesses.</p>
<p>Credit rating agencies are <a href="http://www.spii.org.za/index.php/debt-uneven-development-and-capitalist-crisis-in-south-africa-from-marikana-microfinance-mashonisas-to-moodys-macroeconomic-monitoring/">dangerous</a> institutions. Their mistakes can be catastrophic to investors and the broader economy. As the 2008 world financial meltdown gathered pace, for instance, they gave AAA investment grade ratings to Lehman Brothers and AIG – just before these companies crashed. </p>
<p>No wonder the Brazil-Russia-India-China-South Africa 2016 summit in Goa <a href="http://timesofindia.indiatimes.com/business/india-business/BRICS-countries-agree-to-set-up-credit-rating-agency/articleshow/54881697.cms">agreed</a> to explore setting up an independent BRICS Rating Agency based on “market-oriented principles” to “further strengthen the global governance architecture.”</p>
<p>However, given how poorly “market-oriented principles” hold up in today’s chaotic world financial system, this strategy appears as serious as the BRICS’ alleged “governance” reform of the International Monetary Fund in December 2015. Then, aside from South Africa which lost 21% of its vote, four BRICS members <a href="http://links.org.au/node/4704">increased</a> their IMF voting shares. This was mainly at the expense of poor African and Latin American countries.</p>
<h2>Reasons for escape</h2>
<p>This week the main question to ponder is why, given utterly zany politics and the stagnant economy, South Africa was not <a href="http://www.cnbcafrica.com/news/financial/2016/12/02/sp-sa-long-term-local-currency-ratings/?utm_source=CNBC+Daily+Newsletter&utm_campaign=b04ecc07ab-RSS_EMAIL_CAMPAIGN_Daily&utm_medium=email&utm_term=0_37ea1a8e5e-b04ecc07ab-216204545">downgraded</a> all the way to junk. S&P lowered the risk rating of local state securities, but not the sovereign debt grade considered by foreign investors.</p>
<p>The main reasons Standard & Poors gave for the reprieve are telling: </p>
<blockquote>
<p>“the ratings on South Africa reflect our view of the country’s large and active local currency fixed-income market, as well as the authorities’ commitment to gradual fiscal consolidation. We also note that South Africa’s institutions, such as the judiciary, remain strong while the South Africa Reserve Bank (SARB) maintains an independent monetary policy.”</p>
</blockquote>
<p>This statement requires translation.</p>
<p>What Standard & Poors meant by a “large and active local currency fixed-income market” is that exchange controls stipulate that pension and insurance funds must keep 75% of assets inside the country. This creates a large artificial local demand for state securities.</p>
<p>“Gradual fiscal consolidation” was a reference to Finance Minister Pravin Gordhan’s <a href="http://mg.co.za/article/2010-10-27-gordhan-presents-upbeat-mediumterm-budget">promise</a> that the budget deficit would fall from this year’s 3.4% to 2.5% by 2019. But this will require cuts into the very marrow of already <a href="https://www.researchgate.net/publication/276865185_Tokenism_in_South_African_social_policy">tokenistic</a> social grants. It will result in recent increases for 17 million recipients <a href="http://mg.co.za/article/2016-10-28-00-gordhans-politics-of-divide-and-rule">falling</a> below the inflation rate faced by poor people.</p>
<p>To say that “institutions such as the judiciary remain strong” means not only do the courts regularly smack down President Jacob Zuma. They also religiously uphold property rights. In South Africa these are ranked 24th most secure out of 140 countries <a href="https://www.brandsouthafrica.com/news/1324-sound-regulatory-and-business-support-programmes-make-south-africa-your-preferred-investment-destination">surveyed</a> by the Davos-based World Economic Forum.</p>
<p>“The SARB maintains an independent monetary policy” means that in spite of incredibly high consumer debt loads, the SARB has raised interest rates four times since 2015. Nearly half the country’s active borrowers are considered ‘<a href="http://www.ncr.org.za/documents/CCMR/CCMR%20June%202016">credit impaired</a>.‘</p>
<p>Another reason S&P is optimistic is supposedly that “The trade deficit is declining on the lower price of oil (which constitutes about one-fifth of South Africa’s imports)…” In reality, the trade deficit just <a href="http://af.reuters.com/article/investingNews/idAFKBN13P1HU">exploded</a>: from a R19 billion trade surplus in May to a R4.4 billion deficit in October.</p>
<p>Meanwhile over the past month the oil price soared 21%, from $43 to $52 per barrel. OPEC’s latest collusion to <a href="https://www.theguardian.com/business/2016/dec/03/opec-oil-price-deal-doesnt-hold-cards-fracking">cut</a> output is likely to push the oil price past $60 in coming weeks. The stronger rand witnessed over the course of 2016 did not offset that rise because over the last month, the rand fell from a high of R13.2/$ to around R14/$.</p>
<h2>What wasn’t mentioned</h2>
<p>Not only are S&P’s rudimentary observations off target. The silences in its statement are telling. For example, S&P was surprisingly blasé about the country’s foreign debt. The last SARB <em>Quarterly Bulletin</em> <a href="https://www.resbank.co.za/Publications/Detail-Item-View/Pages/Publications.aspx?sarbweb=3b6aa07d-92ab-441f-b7bf-bb7dfb1bedb4&sarblist=21b5222e-7125-4e55-bb65-56fd3333371e&sarbitem=7470">records</a> debt at the highest ever (as a ratio of GDP) in modern South African history. It now stands at 43%. That’s higher than apartheid-era President PW Botha’s 1985 default level of 40%. </p>
<p>S&P also neglected critically important factors such as illicit financial flows, <a href="http://www.gfintegrity.org/report/illicit-financial-flows-from-developing-countries-2004-2013/">estimated</a> by Global Financial Integrity at R300 billion per year. It also failed to notice the persistent balance of payments <a href="https://www.resbank.co.za/Publications/Detail-Item-View/Pages/Publications.aspx?sarbweb=3b6aa07d-92ab-441f-b7bf-bb7dfb1bedb4&sarblist=21b5222e-7125-4e55-bb65-56fd3333371e&sarbitem=7470">deficit</a> due to annual corporate profit and dividend outflows of more than R150 billion per year, following excessive exchange control liberalisation.</p>
<p>S$P does not mention South Africa’s <a href="http://www.economist.com/indicators">exceptionally high</a> international interest rates on 10-year state bonds. At 9% these are lower only than Brazil and Turkey. It ignores corporate overcharging on state outsourcing, which the Treasury’s Kenneth Brown <a href="https://businesstech.co.za/news/government/139193/shocking-levels-of-fraud-and-inflated-prices-cost-south-africa-r233-billion/">says</a> costs taxpayers R233 billion per year. </p>
<p>To S&P’s credit, however, the agency was concerned about “the corporate sector’s current preference to delay private investment, despite high margins and large cash positions”. In an opposite signal, though, S&P <a href="http://www.fin24.com/Companies/Mining/sp-ratings-boost-for-anglo-as-miner-wins-war-on-debt-20161202">awarded</a> the country’s leading <em>disinvestor</em>, Anglo American, an improved credit rating on Friday.</p>
<p>It still strikes me that like the <a href="http://mg.co.za/tag/gupta-family">Gupta</a> and <a href="http://www.forbes.com/forbes/welcome/?toURL=http://www.forbes.com/profile/johann-rupert/&refURL=http://www.bing.com/search?q=rupert+family&form=IE11TR&src=IE11TR&pc=EUPP_DCJB&referrer=http://www.bing.com/search?q=rupert+family&form=IE11TR&src=IE11TR&pc=EUPP_DCJB">Rupert</a> families, the ratings agencies will continue attracting the accusation of “state capture” insofar as the public policy this neoliberal foreign family dictates is also characterised by short-term self-interest, occasional serious oversights (such as those above) and national economic self-destruction.</p>
<p>The only reasonable solution is progressive <a href="https://theconversation.com/south-africa-needs-tougher-exchange-controls-before-junk-status-hits-68085">delinking</a> from the circuits of world finance through which these agencies accumulate their unjustified power.</p><img src="https://counter.theconversation.com/content/69803/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Patrick Bond 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>South Africa is breathing a sigh of relief after escaping a credit rating downgrade. But there are still serious concerns around structure of the country’s economy and finances.Patrick Bond, Professor of Political Economy, University of the WitwatersrandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/692432016-11-22T20:01:03Z2016-11-22T20:01:03ZSouth Africa is skating on thin ice as rating agencies weigh their options<figure><img src="https://images.theconversation.com/files/147008/original/image-20161122-11000-1vlrf0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's Finance Minister Pravin Gordhan is fighting to stave off a downgrade by ratings agencies.</span> <span class="attribution"><span class="source">Siphiwe Sibeko/Reuters</span></span></figcaption></figure><p>Rating agencies are shortly expected to announce their decision on whether to retain South Africa’s sovereign credit rating, or to downgrade it. The current rank <a href="https://www.moodys.com/page/search.aspx?cy=global&kw=south+africa&searchfrom=GS&spk=qs&tb=1">assigned by Moody’s</a> is two notches above sub-investment grade (with a negative outlook). Fellow agencies Fitch and Standard and Poor’s both rank South Africa just one notch above “junk” status.</p>
<p>The country was able to avoid the downgrade to “junk status” in both May and June. But the scheduled reviews have reignited fears of a possible downgrade, a decision that would set the stage either for South Africa’s economic revival, or its demise.</p>
<p>Despite minor differences, all three agencies weigh up a number of ubiquitous and <a href="http://faculty.nps.edu/relooney/3040_2.pdf">well-defined criteria</a> when assigning a rank to a country’s sovereign debt. In the current review of South Africa they will be scrutinising growth prospects, the fiscal balance and its external debt levels particularly closely. </p>
<p>In their earlier reviews the rating agencies warned that South Africa’s annual growth rate would need to increase to at least 1% or it would risk <a href="http://www.moneyweb.co.za/news/economy/south-africa-can-avoid-credit-downgrades-gordhan/">falling to “junk” status by year-end</a>. Finance Minister Pravin Gordhan recently reiterated the warning. </p>
<p>Unfortunately, South Africa’s annual growth prospect has been revised down from <a href="http://www.treasury.gov.za/documents/mtbps/2016/mtbps/MTBPS%202016%20Full%20Document.pdf">0.9% to 0.5% </a>. The outlook for 2017 is more positive in that the growth rate is expected to increase to approximately 1.3%.</p>
<p>But to achieve positive growth in the coming year the government has no choice but to introduce much needed and widely advocated structural reforms. These are being spearheaded by Gordhan. He has also been leading ongoing negotiations between the National Treasury and rating agencies in a bid to ward off a downgrade. </p>
<p>The negotiations have resulted in a number of tangible measures being set. These include a more sustainable supply of energy, greater efficiency at state owned enterprises, market reforms that can lead to greater competition and labour market reforms. </p>
<p>But a number of structural factors still stand in way of meaningful progress. </p>
<h2>The hurdles</h2>
<p>The most notable is the skills mismatch which has led to a labour market that is rigid and inaccessible to many. Reforms will therefore have to be centred on more flexibility in wage contracts and more effective collective bargaining structures. Also key will be the creation of more jobs in the private sector, particularly among small to medium enterprises. They are viewed as being more labour intensive and can therefore absorb a higher share of the unskilled labour. </p>
<p>Success on these fronts will depend on a commitment from both large business as well as trade unions.</p>
<p>The fiscal balance is also an area of concern. Here the National Treasury must commit to reducing the consolidated budget deficit to at least 3% of GDP. And it must make a commitment to maintain this for the next two financial years. In addition, the debt-to-GDP ratio must stabilise to below 48%. Achieving this is going to prove challenging for two main reasons. </p>
<p>Firstly, poor performing state owned enterprises, for example, the power utility Eskom and South African Airways, are putting an undue burden on the state’s resources. Calls to privatise these entities have so far gone unanswered. </p>
<p>Equally important are the burgeoning public wage bill as well as exceedingly high wasteful expenditure. The most recent report released by the country’s Auditor General pointed to <a href="http://mg.co.za/article/2016-11-16-government-state-owned-entities-topple-billions-in-irregular-expenditure">shocking levels of wasteful expenditure</a> by municipalities totalling almost R50 billion in the 2016 financial year. Much of it has been attributed to blatant deviations from procurement guidelines. </p>
<p>How the National Treasury responds will certainly test its commitment to short-term cost cutting measures. It will also point to how it aims to achieve growth within a more prudent fiscal framework.</p>
<h2>Institutional strength</h2>
<p>An equally important criteria that ratings agencies assess is the country’s institutional strength. This considers whether a country’s institutional structures can support its ability and willingness to repay its debt. The government’s capacity to conduct sound economic policies that foster economic growth and prosperity are also considered.</p>
<p>Political tensions within the ANC will have a negative influence on the rating. Trumped-up charges levelled against <a href="http://ewn.co.za/2016/10/11/Finance-Minister-Pravin-Gordhan-issued-with-summons-for-fraud">Gordhan</a> combined with President Jacob Zuma’s attempts to delay the release of a report on state <a href="http://ewn.co.za/2016/10/27/jacob-zuma-seeks-to-postpone-court-hearing-into-state-capture-report">capture</a>, have not inspired confidence. There were silver linings in the fact that the country’s National Prosecuting Authority decided to drop the charges against <a href="http://www.bbc.com/news/world-africa-37822600">Gordhan</a> while a court ruled that report on state capture should be <a href="http://www.iol.co.za/business/markets/currencies/rand-rises-after-go-ahead-for-statecapturereport-2086288">released</a>.</p>
<p>But the continued deafening silence from Zuma as well as his ministers is bound to be noticed. The clear lack of leadership and the desire of some to hold onto power, adds political risk for which the country is likely to be judged harshly. </p>
<h2>The effect of a downgrade</h2>
<p>Asset markets have already priced in a possible downgrade. But a negative decision will still have major ramifications for South Africa. </p>
<p>A downgrade to speculative grade would imply that South African investments are considered to be high risk. Potential investors will demand a higher premium to take on the higher risk. In the worst case scenario the country will no longer be able to secure any credit. </p>
<p>The immediate response to a potential downgrade is that the country may experience short-term losses in the value of currency and the bond market. It may also experience an exodus of capital. But according to <a href="http://www.iol.co.za/business/news/sa-banks-able-to-deal-with-downgrade-2088635">the governor of the reserve bank</a>, banks are adequately capitalised and hence these developments are not expected to permanently effect the functioning of the domestic financial market. </p>
<p>In addition, the country’s resilience may come in the form of strong policy frameworks, a flexible exchange rate, relatively healthy corporate balance sheets and a large share of external debt being rand denominated. A better than expected commodity cycle could also help. These factors, combined with the Reserve Bank’s goal of keeping inflation in check (which offers some confidence in the stability of the country’s institutions) may just be South Africa’s saving grace.</p><img src="https://counter.theconversation.com/content/69243/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>South Africa has made some progress in fixing problems identified by ratings agencies. But there are a number of outstanding issues that might mean the country is given ‘junk’ status.Fatima Bhoola, Lecturer in Economics, University of the WitwatersrandNimisha Naik, Lecturer in Economics, Macroeconomics and Mathematical Economics, University of the WitwatersrandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/613352016-07-04T04:02:24Z2016-07-04T04:02:24ZWhat South Africa needs to do to step away from the downgrade precipice<figure><img src="https://images.theconversation.com/files/128279/original/image-20160627-28379-6xt2g8.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">Shutterstock</span></span></figcaption></figure><p>In early June the international debt rating agency Standard & Poor’s granted a <a href="http://www.bbc.com/news/business-36443111">stay of execution</a> by not downgrading the South African government’s IOU certificate to a “junk debt” status. </p>
<p>This preserved the country’s credit worthiness as investment grade. South Africa should therefore be able to keep on sourcing external finance at a relatively affordable cost. </p>
<p>But Standard & Poor’s maintained a negative view of South Africa’s economic prospects. Moody’s passed a similar verdict last time it <a href="https://www.moodys.com/research/Moodys-confirms-South-Africas-sovereign-rating-at-Baa2-and-assigns--PR_348291">revaluated the country</a>.</p>
<p>The close shave should be an opportunity for government and all stakeholders to step back and reflect on the averted economic calamity. In a sedate and panic-free mindset they can begin to set the economy and its management on a transformative growth path.</p>
<h2>What went wrong</h2>
<p>How did South Africa earn this negative outlook and why is it teetering on the precipice of a downgrade?</p>
<p>A reasonable explanation for the current state of affairs can be found in a combination of factors. These include:</p>
<ul>
<li><p>a drop in commodity prices. This has had a significant impact on a major source of foreign exchange earnings;</p></li>
<li><p>a disruption in production due to industrial action by labour unions that has been badly managed by all concerned: the private sector, union leadership as well as government; and </p></li>
<li><p>the troubling mixed signals the country’s leadership has been sending to the nation and the world on effective governance. </p></li>
</ul>
<p>These are factors over which the country can exercise control. </p>
<p>The protracted labour strikes and questions around governance are particularly responsible for the rating agencies maintaining a negative outlook. In my view these factors, alongside growth-oriented structural reforms, are standing in the way of the country getting onto a long-term sustainable growth path.</p>
<h2>Government responds with band aid</h2>
<p>The government revealed its strategy for dealing with the dim economic state that precipitated the threat of downgrade in its <a href="http://www.bbc.com/news/business-35650701">most recent budget</a>. It was the usual response of austere posturing made up of a concoction of measures. These included government spending cuts, a civil service job freeze and increases in revenue by hiking “sin taxes” on alcohol, tobacco, sugary drinks, fuel, environmental degradation and capital gains.</p>
<p>These measures amount to nothing more than band-aid treatment. The rating agencies weren’t fooled by the budget measures. This is because they know that South Africa’s economic fundamentals are not that bad: the issue is the country’s future prospects. </p>
<p>This is best illustrated by comparing South Africa with its BRICS peers (Brazil, Russia, India and China) in terms of some of the metrics reflective of a country’s credit worthiness. It in fact doesn’t fare too badly.</p>
<p>The ratio of public debt to gross domestic product of Brazil and India are in the 60% range, way higher than South Africa’s <a href="https://www.prudential.co.za/insights/articlesreleases/is-junk-status-an-imminent-threat-to-south-africa">50% ratio</a>. Of this only about 10%-20% (of total national debt) is attributable to external debt, the lowest among its peers except China. Its tax management system and financial system infrastructure <a href="https://www.enca.com/sa-leads-world-financial-markets-far-behind-human-capital">rank highly</a> among emerging-market countries. </p>
<p>Its main areas of dubious distinction are in the economic growth and current account deficit comparisons. This is where it lags behind most of its peers. South Africa has historically recorded the lowest growth rate among its peers, with a projection that this year’s may be in the range of 0.9%-1.7%. Its current account deficit is again the worst, with a five-year average of -5.5%. This is generally considered a red flag to fickle foreign investors thinking of exiting.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=386&fit=crop&dpr=1 600w, https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=386&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=386&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=485&fit=crop&dpr=1 754w, https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=485&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/128277/original/image-20160627-28366-p1p6s5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=485&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">World Bank’s World Economic Indicator annual series</span></span>
</figcaption>
</figure>
<h2>How the threat can be averted</h2>
<p>The main thrust must be to grow the economy rather than imposing willy-nilly spending cuts and fixating on taming inflation.</p>
<p>The increase in revenue via “sin taxes” instead of income or profit tax is wise. But a much less burdensome revenue source would be to stop the illicit flow of funds out of the country. Global Financial Integrity <a href="https://theconversation.com/flight-of-corporate-profits-poses-biggest-threat-to-south-africas-economy-61337">estimates</a> that the leakage of funds from South Africa, mainly from multinational corporations, was R330 billion per annum (about US$21.6 billion at current rates) between 2004 and 2013.</p>
<p>One major contributor is transfer pricing by multinational firms. Transfer pricing is when a company, seeking to avoid taxes, can make its profit/loss record show loss. This is achieved through increased expenses by fictitiously providing inputs/parts/advice to a branch in another country. By falsely reporting a loss it cheats the South African government of taxes it would have rightly paid on its true profit.</p>
<p>Other steps that could be taken, especially on managing the damaging recurring strikes, include:</p>
<ul>
<li><p>firms extending profit sharing fairly. This can be done by increasing the salaries of line-workers or by giving workers equity share-based wage increases;</p></li>
<li><p>the enforcement of black economic empowerment measures to redress the destructive legacy of apartheid; and</p></li>
<li><p>unions sensibly and nonviolently demanding fairness by negotiating in good faith.</p></li>
</ul>
<p>In addition, the government should pay more attention to decoupling revenue and, by extension, the budgetary process and economic growth, from commodity price volatility. This can be achieved by government building “rainy day” reserves. Taxes, or a royalty tax, could be imposed when commodity prices rise beyond a certain level. The funds can be used for important ongoing capital and social projects (such as maintaining or growing the national productive capability via strategic funding of education) during economic downturns.</p>
<p>The country should also institute economic management mechanisms such as creating a sovereign wealth fund for capital investment planning. This should be used for macroeconomic stabilisation and expanding the production base. Countries that have done this successfully include Norway, Kuwait and United Arab Emirates. </p>
<p>On top of this South Africa must begin to use its superiority in manufacturing capacity and services such as banking and information and communications technology, to grow intracontinental trade.</p>
<p>The issue of job creation must also be given a serious rethink. And careful consideration of ownership structures is particularly germane given the lingering legacy of apartheid. But privatisation of all activities is not a cure-all. For example, government may not need to run an airline business. This can be handled by the private sector or through a public-private partnership. On the other hand it certainly can insist on having a say in rail transport, electricity and water. </p>
<p>These production activities affect most households in terms of price affordability and employment.</p>
<p>Finally, to address concerns about corruption and state capture the government needs to adopt a servant-governance approach by strengthening institutions and ensuring their independence from political influence.</p>
<p>If pursued diligently, these measures would save South Africa from what currently looks like constant danger of a downgrade.</p><img src="https://counter.theconversation.com/content/61335/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kalu Ojah 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>South Africa’s response to the country’s economic woes has amounted to little more than band-aid treatment. Government must do more to set the economy on a solid growth path.Kalu Ojah, Professor of Finance, Wits Business School, University of the WitwatersrandLicensed as Creative Commons – attribution, no derivatives.