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Moody’s downgrade and what it means for investors






Maarten Ackerman, Chief Economist and Advisory Partner, Citadel


30 March 2020: The Moody’s downgrade of South Africa’s credit rating should have happened long ago. We’ve known for a long time that our fiscal metrics have been unsustainable, so despite the coronavirus, this is unsurprising.


With all that has happened in the world over the past few weeks, markets had clearly signalled that a downgrade would take place and had already started pricing this in. It is quite evident that in this type of environment, South Africa simply would not be able to reach the targets that had been set during the National Budget in February


If the global outlook had not deteriorated so significantly, there might have been a chance that Moody’s would still have acknowledged the reform-minded government’s potential to set the economy right. In the event, this was not to be and Moody’s hands were effectively tied.


While the electricity supply constraints, labour market “rigidities” and most other structural issues which have existed for some time were cited by Moody’s, the key new element at this stage is the deterioration in the global outlook. With a global recession on the cards, South Africa will remain in recession and, as a result of that, we will not be in a position to meet our fiscal targets.


The bond market had started pricing in a downgrade earlier this week as many foreigners sold out, with long-term bond yields moving high into double digit territory, although they have pulled back a little bit. When the market opens on Monday, there is likely to be more volatility and pain. SA will, however, remain in the FTSE World Government Bond Index (WGBI) for another month and then there might be further outflows in April as a result of us being withdrawn from the Index.


Excellent time to lock in the higher yields


For investors with a longer-term horizon, this presents an opportunity to lock in those higher yields. In the longer term, the bond market should perform well, given the higher interest rates that we are now able to access, while inflation is still quite muted.


These are definitely challenging times, not only for South Africa but for the whole world. It’s the first time that we are in lockdown, which is enough to be concerned about. Add to that the fear of contracting the virus itself and then potentially dealing with a lot of financial uncertainty.


What we do know is that, in time, this will pass. And even if there is more pain to come in the near term, there will definitely be more upside over the longer term.


Diversification pays


At Citadel, we know that diversification is important in portfolios and it is times like these when such a strategy comes to the fore. Having investments spread across geographies, across asset classes and across investment styles will pay off when volatility hits markets and uncertainty is rife. Now is the time for investments to be positioned defensively and prudently. We have built shock absorbers into our portfolios and will be raising the bond exposure now, locking in double-digit yields as well.


This strategy should carry investors through for at least for six years while we can wait for all of the effects of today’s reality to settle and return to normal and lift the growth component of their portfolios.


In time, there will be a solution to the current health and financial issues. The willingness for the global community to shut down and take the seriousness of this virus to heart, inspires confidence in me that we will be able to get through this successfully.


South Africa is facing its challenges head on


This crisis just shows again how uniquely we can work together and how willing South Africans are to find solutions.


We need to applaud our leadership for the very difficult but correct actions that they are taking right now. All hands are on deck as we go through this challenge, and we will get to a stage where the economy will open up and we can again work on the structural issues that we had already begun addressing before the crisis took place. Unfortunately, these issues are now even more severe given the headwinds from the global economy.


Having said all that, we’ve been sub-investment grade before, and this is not the first time that we’ve been in this situation. A sub-investment grade credit rating doesn’t mean that it’s the end of the economy, and that we can’t do business. There are many sub-investment grade economies that are doing quite well. In fact, as an example, history shows that countries such as Brazil didn’t collapse after being downgraded to sub investment grade and in many ways started to perform better given that investors had greater certainty.


This time around, unfortunately, we are in an economic slump and grappling with the COVID-19 crisis. So the focus now, just like in China and also reflected in messages from the G20, is to focus on the health of our society and make sure that we curb the virus’ spread, before we begin working again on the economy.


Light at the end of the tunnel


I truly believe that we went into this crisis with a reform-minded government, and that won’t change coming out of the crisis. There will also be many lessons that will be learnt in terms of how we can co-operate and work together from this crisis. Not only that, the strength and resolve shown by our government and the leadership characteristics that have come to the fore in this time of greatest need, bode extremely well for our future.


We do face an extremely challenging time ahead. The economy has been severely impacted by the pandemic and national lockdown, but there is more than enough monetary support globally – in fact, the highest in global history. Even our own central bank cut rates and introduced quantitative easing. So as soon as infections move past their peak and we can open for business again, we should see quite a large and rapid rebound with all the proactive support that is already in place.


That won’t change the fact that we are facing severe structural economic issues and that our credit rating is now sub-investment grade, but this isn’t the end of the road for the country. And from a portfolio point of view, our concerns over these exact circumstances have influenced our allocation decisions for the past couple of years. We have been overweight in terms of global assets for some time, with shock-absorbers for a weaker currency.

Source: Cambial Communications
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