Savvy investors are unlikely to be deterred by the South Africa credit rating downgrade, which is driven by that most volatile of factors, political risk, says Alnoor Amlani
This article was first published in the July/August 2017 international edition of Accounting and Business magazine.
Recently two of the three major credit rating agencies downgraded South Africa’s government bonds to ‘junk’ status. Standard & Poor’s lowered its rating from BBB- to BB+, and Moody’s soon followed with a similar rate cut. The move followed the firing of finance minister Pravin Gordhan by South African president Jacob Zuma.
S&P cited the impact of divisions in the government as the reason for the downgrade; its view was that ‘political risks will remain elevated this year, and that policy shifts are likely, which could undermine fiscal and economic growth’.
Political risk is usually just one of many factors that determine ratings, but in Africa it is normally the one with most impact. The problem is that this factor is often too volatile and simply too difficult to objectively assess and compare.
Credit ratings have been falling across the board, with some of the most developed nations taking prominent cuts. Britain lost its AAA rating last year, after voting to leave the EU, and the US took a cut following the financial crisis. However, the global market for government bonds continues to improve, highlighting a major disconnect between the rating agencies and the market. Many question the relevance of rating agencies today, as a result.
Since their introduction a century ago, sovereign credit ratings have had a turbulent history. After the Great Depression, 21 out of 58 nations defaulted on their international bonds between 1930 and 1935. Since then more than 70 governments have defaulted at least once on their domestic or foreign debt.
Assessing risk is a difficult task. Rating agencies have to draw comparative data across the globe and therefore have to consider the available comparative data such as per capita income, GDP growth, inflation, the level of government debt and default history, and weigh these against their view of political risk, regulatory risk and other unique factors. In the case of South Africa there is certainly political uncertainty.
The effect of rate cuts by international agencies on developing countries is far more pronounced than in developed countries. The South African government will now find it harder to borrow in the international markets, and in all likelihood will have to borrow more in the local market. This could mean increased interest rates for individual South Africans to bear. Stock values for banks in South Africa tumbled soon after Gordhan was replaced and have lost 8% of their value to date, with the rand losing 3% of its value.
Traditionally, because of the lack of information in Africa’s emerging economies, risk is managed through detailed and often expensive due diligence. But for those willing to go beyond broad global credit ratings, there are often good and low-risk investments to be found. Africa’s rising crop of self-made millionaires are testament to this. A savvy investor in Africa today should be willing to go the extra mile and gather the data needed to make investment decisions while also considering global ratings.
Alnoor Amlani FCCA is an independent consultant based in East Africa
"For those willing to go beyond broad global credit ratings, there are often good and low-risk investments to be found"