Junk Status Is Like An Iceberg: Either Go Around Or Go Down

Thursday, 6 April, 2017 - 12:50

Over the last 35 years these agencies have downgraded about 20 countries to junk status, only six have ever regained back into investment territory

Let's say that every year you went and purchased something new that you really needed or wanted (i.e. nuclear deal with Russia) and that purchase was always expensive and required longer than one year to pay off (1 trillion dollars) but that's okay because every year you plan to make more money than you did the year before (taxes collected). So, the extra funds will easily pay for that new loan amount over a few years (bonds) and the loan is easily achieved because you have a healthy credit score (rating agency, Moody's).
How does your entire life come crashing down?

You ask your accountant to buy something that someone you adore really wants. However, your accountant says that you can't afford it and explains that it is more of a want than a need. You tell the person that you adore that the accountant said that you can't have it but the adored won't accept that and devises a plan to show you that it can be done. So, you comply, which entails firing your expert and hiring a puppet.

Herein lies the consequence, the agency rating you and the running of your affairs regarding your creditworthiness, competency and affordability is an expert of experts and will work out that a muppet is now in charge of your affairs and rank you accordingly.

In the real-world, rating agencies are absolute. Smoke and mirrors with double rainbows, the best sales pitch and promises, don't account for anything because rating agencies are linked to a fixed legal barrier.

Licensed investors, banks, mutual funds, hedge funds, pension funds and asset managers are prevented by institutional guides and in most cases law in certain territories, especially first world countries from investing in junk status countries, be that with government or other businesses within that country.

This extends to private investment clients too, as in many cases this policy is built into their internal disclaimer. So, let's say that someone lives in London and has an investment account at Credit Suisse.

This investor can lend about 80% of the value of their own money back that they have in the stock markets so long as their money is invested outside of junk status countries. As soon as a territory becomes junk status, that private client will be notified and told to either pull out from that country or be forced to settle their loan. There could be tens of millions of these people, which could have invested in their personal capacity into large corporates that issued bonds like public company mining houses.

Reports show that about 40% of government bonds are funded by foreign institutional money and most of that money comes from countries that cannot invest in junk bonds. Those outside the junk status prohibition territory will still see our depreciating currency as unfavorable and want to exit, simply from a financial perspective.

Just like any transaction where money is involved, there are agreements and clauses that last the lifetime of each loan. The consequences now in those clauses regarding junk status could be anything from higher interest to faster payment or calls on loans or auto transfers to other parties and so on. These triggers are all negative for South Africa but favourably designed to protect the investor.

South Africa is not alone, the entire world is not doing well. President Trump has had great stock market rallies but in terms of their currency – unpredictable and volatile. Theresa May, Prime Minister of the United Kingdom triggered article 50 which will maintain the pounds downward spiral until real certainty regarding Brexit is contractually signed with each of the 27 countries – this is years away. Without these two countries experiencing their own volatility, the dollar to rand value would be well over 20 to 1 and the pound would be over somewhere north of 30 to 1, timing has been our saving grace but it's far from over.

In reality, all of our previous 2008 issues like unemployment and labour unrest has only escalated, which justified that we have periodically since 2009, suffered rating cuts by all three top ratings agencies.

The big three credit rating agencies are Moody's, Standard & Poors (S&P) which account for 80% of the market share and Fitch Ratings with the additional 15%, leaving 5% to a handful of smaller players.

Credit ratings play a crucial role in determining bond risk and how much entities that issue debt, must pay. The quick and the short is that South Africa can't now lend money where money is easily available because of laws regarding junk status and if we can manage to get around it, it will be more expensive, probably 3% more, meaning taxpayers are going to have to contribute that shortfall.

Over the last 35 years these agencies have downgraded about 20 countries to junk status, only six have ever regained back into investment territory. The fastest was just under 1 year, the slowest was almost 12 years and the average was 7 years. It would take two of the three ratings agencies putting us into junk status to stamp our fate long-term but that's being optimistic.

In the same way that people ask for bank loans, governments do. They go on road shows to source financing from international funds that have trillions to spend. Our finance minister is cap in hand several times a year, explaining what projects need funding and how these funds are going to grow the tax base and the economy.

Our problem for almost a decade has primarily been corruption, from that we have a lack of prudent spending from tenders to ethical financial priority towards the poor. No one should really have an issue with tenders being won by friends and family. You often find the workplace is full of people that got their head start from a colleague. The issue lies in these people not doing the work, missing delivery deadlines and or costing more than the original tender winning costs but luckily our economy has had a healthily reserve so from that aspect we've never experienced a consequence.

Experts, of which I am not, have suggested that it will take about 4 years to get out of junk status with very restricted spending but I feel that with the right captain and an entirely new top 6 dream team, it would take us 4 to 6 months from that first rating assessment of the new team. The only question is how long will it take for the right captain.

If South Africa were to be downgraded to junk status by Moody's on Friday‚ which would be the next grade down from where we are at, we would be in a freefall from day one.

Certain spending can't be put on hold and they always increase in costs. South Africa is facing congestion and structural issues that are only going to get worse, expanding roads, more electricity demands, with existing costs like paying government wages, 17 million people's grants and tons of other commitments will still need to be funded somehow. Therefore, the prime lending rates will have to rise because government will need more money.

Our national debt by in large takes the form of government bonds‚ which is a form of borrowing in foreign currency. The national current debt of South Africa is about R2 trillion, meaning that South Africa pays about $8,067,780,000 in interest per year, (per second $256). To break this down even further, the debt per citizen is $2,690 so our debt as a percentage of Gross Domestic Product (GDP) is about 45 percent.
So how important is a successful vote of a motion of no confidence?

It's the only aspect that could change our junk status fate. To the poor, the 17 million people on government grants and most South African's, it's life-threateningly critical.

Photo courtesy: TimesLive


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