The economic reality behind South Africa’s credit ratings
- J Brooks Spector
- South Africa
- 29 Oct 2013 (South Africa)
In response to Finance Minister Pravin Gordhan’s mid-term budget speech and his comments on ratings agencies and the role of the nation’s media, J. BROOKS SPECTOR contemplates the circumstances of South Africa’s economic future - and the increasingly shark-infested waters it finds itself in.
Back in the 19th century, in the heyday of railroad and canal construction around the globe, along with vast industrial-size mineral exploitation, nations and companies chartered by national governments routinely issued beautifully engraved, elaborately illustrated certificates for bonds and stock shares they sold to investors around the world. These were purchased by investors - usually in more developed parts of the world - on the basis of whatever arguments for the viability and profitability they could find - or believe. Based on whatever information potential investors could find, gut feelings about the latest offering, and their desires for a profit, money poured into such investments.
Anthony Trollope captured that dog-eat-dog universe perfectly in his novel, “The Way We Live Now”. Sometimes things worked out really well for investors. But in other circumstances, the fancy certificates ended up as pretty engravings, suitable for framing and hanging on the wall. (Curiously, there is now a secondary market for these old certificates - as works of art rather than as units of value for their investment qualities.)
Earlier, of course, things were even riskier. The South Sea Company, the Great Mississippi Company, and an even earlier Dutch tulip bulb investment bubble were all examples of how untrammelled speculation could wreak havoc on economies and the lives of investors alike. Uncomfortably, they were not so very different from the American mortgage bond bubble that led to the financial crisis of 2008. Ultimately, it seems, it’s all about information, risk and reward.
Now, of course, international rating agencies like Fitch, Moody’s and Standard and Poor’s have become one of several tools investors use to make judgements about their potential investments. In particular, they have flourished where - and whenever - investors need presumably unbiased ways of evaluating risks and rewards. Using reports from embassies, international financial institutions, other companies, risk analysis organizations, independent think tanks and their own banking relationships, investors take a deep breath and make their choices about any involvement in a country or a foreign enterprise.
But, one key difference between the 19th century and the present, of course, is the impact of what Thomas Friedman has termed, “The Electronic Herd”. Billions of dollars worth of investment decisions are made via a mouse click at light speed. Once one big international investor makes a decision, the rest of the herd may well follow suit in a matter of seconds.
There are effectively two types of foreign investment. First, there are those bricks and mortar investments in new productive capacity, the tangible stuff that takes time to build and then bring production on stream. This is not the kind of investment that usually moves at the flick of a click. But all the other stuff - all those funds channelled into currency investment vehicles, foreign stocks and bonds – can, and does; sometimes based on thoroughly considered judgements and hard information - or sheer rumour, whim, fear, fantasy. And all of it is compounded by the behaviour of the electronic herd. Those movements of money, even beyond those large “go or no-go” brick and mortar investment decisions like BMW’s decision not to go ahead with a plant expansion for production of a new model of their popular luxury cars, may be what increasingly bedevils South Africa now.
Last Wednesday, following his mid-term budget speech to Parliament, Finance Minister, Pravin Gordhan, speaking on the popular business and finance radio discussion program, “The Money Show with Bruce Whitfield”, expressed his visible annoyance with an increasingly negative outlook on South Africa’s economy - S&P keeps it at BBB with negative outlook - and the government’s financial policies on the part of the international rating agencies. On air, Gordhan called out the head of Standard and Poor’s operation, asking why that an individual still chose to live in South Africa, if things were going to the dogs with such alacrity. (Well, Gordhan didn’t use the phrase, “going to the dogs”, but, listening to the broadcast, one got the hint.)
But according to a range of thoughtful analysts and observers, the keys to solving South Africa’s economic problems will not be found in the policies the finance minister has advocated previously - or announced in his most recent speech. Instead, for example, according to a business analyst close to a number of foreign business leaders, a key continuing problem is the uncertainty over economic policies absent a compelling sense of policy certainty and direction.
This observer noted, “We are continuously asking government for policy consistency and policy certainty. There is so much new legislation that is being bandied around, companies don’t know what to expect.” This includes such areas as the new credit amnesty, new BEE codes, revisions to the Mineral and Petroleum Resources Development Act 2002, revisions to national labour laws, changes in employment equity laws, the licensing of businesses, potential land reform measures, the legal role of traditional healers and a new intellectual property policy that will not give appropriate credence to respecting intellectual property rights. As a result, adds this individual, “Small wonder companies are hesitant to invest in South Africa. Rather, hold on until you see which direction we are going in. FDI is going where it is more attractive”. Not a good prognosis, that.
Meanwhile, a leading investment analyst added that in his view, rating agency “Fitch’s comments last Friday were very much to the point; while SA keeps spending more than it is earning and while it remains on a low growth path, the spectre of ratings downgrades will persist. Moody’s appeared more impressed with the MTBPS [Gordhan’s speech] but even there the agency gave warning that growth needed to improve and that the impediments to implementing the NDP needed to be removed.”
This analyst added that the planned belt-tightening on government expenditure described in Gordhan’s speech was important and if he were fully in charge of the entire government’s spending, “I suspect ratings agencies and the public at large would sit up and believe that a new round of economic growth was just around the corner. Alas, he isn’t in charge.” As a result, this analyst cautions the country is but two notches away from junk status as far as the country’s sovereign debt rating is concerned. “A downgrade or even the threat of one would make SA’s borrowing costs higher than they are currently.” And that would have a serious impact on the entirety of South Africa’s budgetary and financial world.
Turning to South Africa’s oft-noted, relatively favourable GDP/debt ratio, he adds that while the usual figure for the country is usually seen as around 39% (compared to much higher numbers for the US, Japan, and the UK), such a putatively favourable “figure does not include the debt of State-Owned Enterprises (SOEs). According to Konrad Reuss of Standard and Poor’s [the target of Gordhan’s ire on radio], if the debt of those SOEs were factored in, the real debt/GDP figure would be significantly higher.” This is particularly important since so few nations still have SOEs, having privatized them years before.
But Gordhan’s financial management burdens actually go beyond these difficult but primarily domestic issues. A leading business journalist called the writer’s attention to a recent - and rather dire - IMF assessment of South Africa. A key fact about this report is its methodology. It compares data from a group of economies similar to South Africa’s, but over time. This journalist noted that while nobody in South Africa believes the country’s debt is a major issue since, relative to its economic peers, SA’s debt has been below the average for decades, it is now above the average. He adds, “South Africans are very confident that the rating agencies have been put on hold - but when you look at this comparison, I think our chances of avoiding a downgrade are much higher than commonly thought.”
Paradoxically, the real trigger for such a downgrade may well be external rather than domestic. In this case, a tapering off of the American Federal Reserve Bank’s quantitative easing policy “could make the tide flow out very quickly, and then we will see who is wearing bathing trunks and who is not!” The heart of this point, of course, is that South Africa’s economy does not exist in a vacuum - it is at the mercy of both Friedman’s electronic investor herd every bit as much as the policy decisions made in distant quarters by other governments, for reasons unrelated to the needs or desires of South African policy makers. And the rating agencies are obligated to attempt to calculate such impacts as well in issuing their decisions.
Naturally, too, the role and impact (and indeed the very methodology) of the rating agencies have their critics. University of Johannesburg political scientist, Peter Vale, for example, argues, “for one thing they are a fad - part of the great and very misdirected rating fashion - universities, schools, even-preschools have joined football teams, coffee shops and (I saw somewhere the other day) prisons as places to be scrutinised by so-called experts! The method used to arrive at any rating is bizarre, to say the least. The belief that complex human institutions can be reduced to numbers or letters should boggle the mind of every intelligent human being... Unsurprisingly, there is perverse dishonesty in all this. These very institutions are themselves quoted on the very stock exchanges which significantly influence their assessments…. they are both game-keeper and hunter!”
Despite such a methodological critique, resource economist, Iraj Abedian, argues these rating agency positions are fully justified. “Understandably the SA Government, and the National Treasury in particular, are jittery about such a prospect! The mid-term budget fulfilled some of the necessary conditions for averting an immediate downgrade, but did not deal with the medium to long term contributing drivers of the country’s credit rating issues.”
Abedian gave the finance minister a good grade for planning to curb expenditures in the short term, for his strong endorsement of the NDP, the rejiggering of the deficit ratios, and expressing some strong intentions to cut the fat - and all that bling - out of the budget. However, the presentation did not deliver on the crucial “how” of reviving economic growth (the key part of fiscal sustainability over the longer term).
Moreover, the speech did not address the vanishing confidence within the investment community - especially for domestic investment - that is a key driver of the country’s low and declining growth. In addition, it failed to set out a clear timeline on cutting all that budgetary fat; it did not address the government’s policy inconsistencies; and it dealt with the country’s medium-term deficit by proffering unrealistic growth projections for the country’s GDP numbers. (In fact, such unrealistic estimates have been a hallmark of South African budget speeches. Unfortunately, bringing the growth numbers down to earth - and reality - only worsens the deficit/GDP ratio.) Additionally, Abedian added, the collapsed export sector, driven by the increasingly difficult circumstances of the country’s mining sector, attracted no solutions in this mid term budget speech either.
Even more challenging, the nation’s social welfare spending has been the fastest growing sector of the budget - and this too was unaddressed. And finally, public sector wages are the second-fastest growing item for the fiscus - yet there was similarly little to encourage the view in this presentation that this government will be able to restrain further growth in this area over the next several years.
Overall, Abedian explained, given such negatives, “the rating agencies are justified to express concerns! SA macro stability is on the edge.” Echoing opinions cited earlier, Abedian added, “the US Fed’s tapering is on hold, the Rand has a breather [and] the pressure is off the macro stability factors for now. [But] when the tapering begins, and the Rand comes under pressure, the fiscal picture can get a lot more bleak!”
Unfortunately, to criticisms such as these being carried in South Africa’s media, Gordhan chose to argue the media should effectively become the nation’s cheerleader, punting the country as a favourable investment destination. Fully investigating and reporting problems is something close to unpatriotic. Or, as Gordhan had told a parliamentary committee the other day, rating agencies had been telling him the “news flow” often portrayed the country in a negative light and that the nation’s credit ratings depended on perceptions of the country from the media (in addition to actual policies). Gordhan said at that meeting, “Whether we are in opposition or in government, whether we are in business or in any other sector of the economy, if you want to shoot this country down carry on with the news flow. Alternatively, change the narrative and talk about how we are going to cooperate to put this country on its proper growth [path] so we can create jobs and we can create optimism and a better investment climate for the country.”
Meanwhile, Brand South Africa (the national marketing agency directed at overseas audiences of tourists and potential investors) CEO, Miller Matola, admitted at a briefing last week that rather than plumping for the national media to become cheerleaders, South Africa’s best hope was the implementation of the government’s 20-year economic growth strategy, the National Development Plan. “The country needs a boost like the one it got from hosting the FIFA World Cup soccer championship in 2010. The next World Cup for us is the National Development Plan, this national vision for the country, and making it work.”
In contrast to South Africa’s apparent policy jumble, however, everybody else on the planet now seems to be focusing even more on capturing new FDI. In just the past day, The Financial Times carried reports of both Iranian initiatives to solicit new FDI and an aggressive new push by the US to do the same thing.
As the Financial Times reported, “President Barack Obama and his senior cabinet officials are mounting a big push to bolster foreign investment in the US – amid evidence that America is falling behind other countries in the race for global capital… reflecting a growing realisation in Washington that the case for investing in the world’s biggest economy is no longer self-evident.”
“In 2000, the US held 37 per cent of the worldwide inward stock of foreign investment but by 2012, that share had dwindled to just 17 per cent. The US attracted $166bn in foreign direct investment in 2012, a 28 per cent decline compared with 2011 and slightly below 2010 levels. This year’s performance could be even weaker, since in the first six months of 2013, the US brought in $66bn in foreign investment, well behind the $84bn of the first half of 2012” and the new FDI push comes after the shutdown/debt ceiling default threat – a one-two punch that made many around the world wonder about the US’ continuing ability to manage its economy and now generate fiscal shock waves that could engulf the rest of the world.
In sum, despite the positive spin coming out of the South African government about the country’s forward momentum, along with its disparaging comments about the roles of the media and the rating agencies, the South African economy seems headed into some increasingly problematic waters. As such, it will need a firm hand on the tiller to see it through - especially as it enters a period in which the run-up to the country’s 2014 national election will be the deciding factor on almost any government decision. DM
For more, read:
- Time to return to normal global monetary policy at AllanGray;
- Pravin Gordhan - Medium Term Budget Policy Statement on the Money Show, a sound clip from the Money Show;
- Media shoots down SA, says Gordhan at Fin24;
- Change the news flow – Pravin Gordhan at City Press;
- Gordhan warns of consequences of negative news on credit ratings at Business Day;
- South Africa stumbles while looking to market itself abroad at the Los Angeles Times;
- Barack Obama mounts big push to bolster FDI in US at the Financial Times;
Photo: South African Finance Minister Pravin Gordhan adjusts his glasses at a news conference during the annual IMF-World Bank meeting at the IMF headquarters building in Washington October 7, 2010. REUTERS/Yuri Gripas