• A Simple Introduction to "Junk" Status And its Implication To Us
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A Simple Introduction to "Junk" Status And its Implication To Us

05 April 2017

By Ricardo Teixeira, CFP® and David Crossley, CFP®, BDO Wealth Advisors

In light of the recent downgrade, it is natural to want to take action, however we urge you to take heed, read the below to get some context, and then consult a professional before you make any financial decisions.

SO WHAT DOES ‘JUNK’ STATUS MEAN?

‘Junk status’ is a colloquial term used to describe a country that has dropped below an acceptable investment grade in the eyes of the three internationally recognised ratings agencies.

A rating downgrade works a little like an interest rate hike. The cost of debt and capital in a country will increase as a result of the downgrade. Similar to an interest rate hike, this will slow down business in a country, increase the borrowing costs for corporates and the government and ultimately puts pressure on consumers. Access to debt (borrowings) can be restricted or even declined because of the risk of the country’s ability to repay the debt

. Read: Infographic from Fin24 on the impact of Junk Status

WHAT IS THE RELEVANCE OF A CREDIT RATING TO A COUNTRY?

A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting.

Ratings agencies are barometers for measuring credit risk.

The table below sets out the scale of ratings for each of the three global credit rating agencies. The red line is the boundary indicating an acceptable versus an unacceptable investment grade risk.

Credit risk

WHAT YOU HAVE’NT READ

It is important to understand that there are a number of different ratings depending on what one is talking about. S&P Global Ratings downgraded South Africa’s foreign currency credit rating to BB+, into speculative grade or so called ‘Junk’ territory. This is generally the “shop window” rating and is the most utilized rating for comparing different countries. Importantly local currency rating for South African bonds is still BBB- (the bottom rung of investment grade).

Currently, around 90% of government borrowing is in local currency and there is little risk that the government will be shut out of capital markets, unable to borrow or maintain interest payments.

WHAT IS THE LIKELY ECONOMIC IMPACT OF THE DOWNGRADE IN CREDIT RATING LIKELY TO HAVE ON ME?

The immediate impact on the domestic economy is likely to be negative as business and consumer confidence is likely to remain depressed. But a catastrophic currency or interest rate shock appears unlikely. However, the South African Reserve Bank will probably hold off on any interest rate cuts until there is less political uncertainty.

The downgrade is negative for South Africa though. The long term impact is likely to affect the following economic variables:

  • Increasing inflationary pressure and impact on cost of living
  • Exchange rate devaluation
  • Interest rates increases which will result in more expensive debt
  • Lower foreign direct investment in SA
  • Possible redistribution of the country’s capital resources
  • Low economic growth
  • Increase in tax rates to supplement revenue collection by Treasury
  • Decrease in grants and social security payments

WHICH COUNTRIES ARE AFFECTED BY A BELOW INVESTMENT GRADE RATING?

The table below indicates other countries that are in a similar predicament to that of South Africa.

Ranking countries

WHAT SHOULD YOU DO?

There is tendency to react emotionally to this state of affairs, given that it has been a situation that has been hanging over our heads for some time.

Now that it has arrived, we are reacting with a sense of disbelief. “How could this ever become a reality?”

However, by understanding the implications and ramifications of this situation we are better able to rationalise and plan accordingly

With acknowledgment to Anchor Capital and Old Mutual Wealth

Read more BDO Insights