The role of the ratings agencies

South Africa’s credit rating has been in the world spotlight recently and our ratings have broadly remained one notch above junk albeit with negative outlook.

June 16, 2016

2 minutes read

But what does this actually mean?

Moody’s, Fitch and S&P (Standard and Poor’s) are the three main ratings agencies.

These agencies provide financial research on bonds issued by commercial (companies) and government entities.

In a South African context, what these “Big Three” agencies essentially do, is evaluate the credit worthiness of South Africa as a business. Let’s call it SA Inc. The ratings I am referring to in this case is the foreign-denominated rating.

It’s very much the same as a company doing a credit check on you as an individual where you are scored according to your income and how well or poorly you service your current debt and expenses.

The service provider then gets a credit score and based on that decides whether or not to take a risk on you by extending you a certain amount of credit.

The outcome of SA Inc’s. credit score then determines how much money the country can raise (by bond debt) and attached to that is the manner in which they are obligated to pay back this debt.

The credit score attached to SA Inc. is then regarded as a gauge by foreign investors as reference to how investable South Africa is.

The debt that is raised is then meant to be used to invest in infrastructure and government spending projects aimed at boosting the local economy.

So what drives a credit rating downgrade?

Well, it works exactly the same way as your personal credit score.

If you default on debt obligations or your personal debt is too high relative to your income, you score lower and thus qualify for less debt or even none at all.

Our current rating at Moody’s for example, is based on the following key drivers:

• Poor medium-term growth prospects due to structural weaknesses, including ongoing energy shortages as well as rising interest rates, further deterioration in the investor climate and a less supportive capital market environment, which is a concern given that South Africa is highly dependent on external capital.

• The prospect of further rises in the government debt-to-GDP ratio implied by the low-growth environment.

Ratings agency outlook

Attached to a country’s credit rating is also an “outlook”.

The outlook is also a “view” of how they see the prospect of the rating either holding up or getting revised lower.

In most cases, outlooks are either “stable” or “negative”.

South Africa’s sovereign credit rating as at June 10, 2016

S&P’s credit rating for South Africa stands at BBB- with negative outlook. Moody’s credit rating for South Africa was last set at Baa2 with negative outlook.

Fitch’s credit rating for South Africa was last reported at BBB- with stable outlook.

In general, a credit rating is used by sovereign wealth funds, pension funds and other investors to gauge the credit worthiness of South Africa, thus having a big impact on the country’s borrowing costs.

We’ve dodged the first round of bullets

With the Big Three having kept South Africa’s debt rating above junk status for now, we are not out of the woods.

There will be another assessment later on in the year (around December) and this will be the real make or break point for SA Inc.

The Rand has strengthened sharply purely on the “relief” of avoiding junk status but I personally would use this opportunity to look at some offshore investments.