How SA could avoid junk status

Cape Town - There are ways SA could avoid a ratings downgrade to junk status and turn the tide on the decline, according to Lesiba Mothata, chief economist at Investment Solutions.

He pointed out that about $1.1trn left emerging markets (EMs) between the fourth quarter of 2014 and the third quarter of 2015, according to the IMF.

In Mothata's view, the authorities should concede that tax hikes are not the solution to SA’s problem.

"If SA becomes a Colombia and hike taxes in the midst of a downgrade crisis, it will take a long time to turn it around (12 years). But if SA is prepared to make tough decisions like South Korea did, then it will not take as long to turn around," he said. South Korea accepted that some conglomerates could go bankrupt. It had no bailouts and had labour flexibility. It turned around from non-investment grade within a year. Romania, for example, took six years to turn itself around from non-investment status.

"When you have a clear policy, it attracts investment," said Mothata.

On top of that what he calls "the correct levers" must be used, namely a focus on high multiplier industries like retail and hospitality, agriculture, construction, personal services, financial services, transport, manufacturing, mining and electricity. It is estimated that an additional R1m spent in the retail and hospitality industry, generates R1.7m and creates five jobs, for example.

Another step proposed by Mothata is for SA to do innovative things. In his view a "global finance centre" should be created in Johannesburg, stretching from Empire Road, Joe Slovo and the M2 - including Hillbrow. He would also like to see lower taxes and the removal of red tape.

Another suggestion by him is to re-positioning ailing mining towns towards different economic models by prioritising SMEs.

"Create micro economic reforms expressed through targeted economic zones. Refocus economic drivers for ailing mining towns. Create smart cities through large-scale infrastructure projects," he said at an information session hosted by the Actuarial Society of SA at Old Mutual in Cape Town.

A survey by Investment Solutions found that global managers found that, despite being put on ratings watch, the rand is up 5.3% year-to-date. They also felt they are compensated for taking the risk of maintaining their positions in SA.

"There hasn't been a mass exit from SA bonds yet, despite negative news," said Mothata.

The survey did find that the global managers were uneasy to provide an expected timing of an SA downgrade and in answering whether information is priced-in or not. On a Purchasing Power Parity (PPP) basis, they did, however, indicate that the rand is one of the most undervalued currencies.

Survey responses from local managers showed six out of the eight expect a junk downgrade of SA in June 2016. They are of the view that information is already fully priced in asset prices and they expect little impact. They based their views mostly on a comparison with other emerging market countries.
 
As for brokers who took part in the survey, four of the five expect a junk downgrade in December, not June 2016. They believe a December rating downgrade by S&P's is already priced in, but not for June.

In their view an adverse market response is likely if the downgrade happened in June, but they do not expect the sell-off to be as much as during “Nenegate”. In the view of the brokers surveyed, the bond market is pricing in a further 3 to 4 downgrades. They expect cash to be king in this scenario.

Mothata pointed out that S&P's has started looking at gross domestic product (GDP) per capita in SA, which has fallen and is expected to be zero in 2016. High levels of debt, therefore, become a problem when it cannot be repaid. S&P's also felt the pace of fiscal consolidation is not fast enough.

S&P's further looks at the debt SA has guaranteed for state owned enterprises (SOEs). In terms of return on equity it is now negative (-3%) and "destroy value". R470bn has been guaranteed by SA, most of which (75%) is for Eskom. The enlarged public sector wage bill is also problematic for S&P's.

"We will be downgraded, but it is not the end of the world. South Korea turned itself around in one year, while Colombia took 12 years," he explained.  

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