Standard & Poor’s fired its first shot by downgrading South Africa’s long-term foreign currency sovereign credit rating to “junk” status. This may sound like financial mumbo-jumbo to most South Africans, and it is. So, let me explain.

“In our opinion, the executive changes initiated by President Zuma have put at risk fiscal and growth outcomes. We assess that contingent liabilities to the state are rising.”

Standard & Poor’s, 3 April 2017

In a nutshell, we are all poorer today than we were yesterday.

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Credit rating agencies are companies that make a living by assigning a “credit rating” to loans raised mostly by governments, municipalities and corporates. That credit rating reflects their assessment of the debtor’s ability to pay back the loan. They evaluate both political and economic risks in making their decision. There are three main credit rating agencies – Moody’s, S&P and Fitch.

All investors and asset managers, domestic and international, rely on these credit ratings to determine whether they will lend the borrower money, and if they do, how much they will ask them to pay in interest.

This is not dissimilar to what banks do to their customers. A good earner with a healthy bank balance, a history of paying off credit card debt and a mortgage-free house can borrow a lot of money at a low interest rate, such as, for instance, 9% per annum. A Sassa grant recipient in a township, as we have recently learnt from the Net1 disaster, pays 164%.

Governments normally have to borrow money as the revenue they collect in taxes is not always sufficient to cover all the expenditure they have to incur. South Africa’s government debt currently stands at R2.2-trillion. The country pays R169-billion in interest every year. We need to borrow R149-billion this year. Government borrows money by issuing “bonds” which investors buy, effectively lending the government money. Government can borrow the money in local currency (rands), or in foreign currency (e.g. US dollars). Foreign currency debt is riskier as it is exposed to the fluctuations of the currency e.g. if South Africa borrows money in US dollars, then the level of debt increases if the rand depreciates. Credit rating agencies then assign a credit rating to such bonds.

Each agency has a slightly different “star” system for assigning credit ratings, hence the AAA, BB+, AA- etc. that you see peppering newsprint. This is irrelevant. In all cases, there are two main categories of risk, investment grade and non-investment grade. Non-investment grade has other names: junk, highly speculative, vulnerable – need I say more? These ratings are applied separately to local-denominated debt and foreign-denominated debt (this will become relevant just now).

Countries with a top-tier credit rating can borrow a lot of money at low interest rates – think USA, Canada, Australia, Switzerland. Think Christo Wiese. Countries with a low credit rating can either not borrow as no one is willing to lend them money, or if they borrow, they pay very high interest rates. Think Phinda Maqubu, who is raising two children in a township and barely getting by.

Junk rating means a higher risk of non-payment or default. Junk means a red flashing light which signals: Stay Away! Most large international investors, such as pension funds, explicitly prohibit their asset managers from investing in any bonds which are rated as junk. Hence we can expect that even with just one agency rating South Africa’s debt as non-investment grade, some investors will disinvest immediately, while others will demand higher interest for the risk of lending money to South Africa. Paying more in interest means there is less money available for infrastructure spend, education, welfare, police and all other services the government is supposed to provide for the taxes that you pay. If the government cannot balance their books through borrowing, the only other source of revenue is taxes.

Hence expect taxes to go up.

So far S&P has downgraded our foreign-denominated debt to junk. They did so because they believe the ANC has lost control over the Presidency and that the National Treasury is likely to embark on a reckless spending spree on projects such as nuclear, which means that they are less likely to have the money to repay debt or channel money into projects that will grow the economy.

S&P fired the first shot. It is a warning shot. Other credit rating agencies are likely to follow. Unless things change, more shots will follow.

The most serious blow will come if the agencies downgrade our rand-denominated debt to junk. South Africa is currently one of the few emerging countries included in the Citi’s World Government Bond Index (WGBI). This means that all investors who track that index have to buy South African bonds automatically. If our rand-denominated debt is rated as junk by S&P and Moody’s, South Africa will be dropped from the index. Immediately on that happening, approximately $10-billion, or R137-billion, will flow out of the country. That is 22% of all foreign investment in South African debt. That will be a catastrophe for the government and the country.

On a personal level, your retirement fund is currently, at least partly, invested in government bonds. Many pensioners and people close to retirement like to invest in low-risk investment products. Low-risk, in investment speak, means more money held in government bonds. If those bonds are dumped by international investors, you will lose a lot of money. The aftershocks of any downgrade are a general negative sentiment of all investors towards South Africa. This means that the value of equities and the rand will fall in sympathy. You will have less in savings and less to retire on, while paying more taxes for fewer government-rendered services.

Honorable Pravin Gordhan performed a Herculean task in persuading credit rating agencies to maintain our rating at investment grade by promising to balance the books carefully and not spend recklessly.

That promise has now evaporated.

It is very difficult to dig your way out of “junk” status. We have a chance to recover. Only one chance. Return Pravin Gordhan to the helm of National Treasury. Do so now.

Join me in marching on 7 April to demand accountability from Jacob Zuma. DM