Why we should take the ratings downgrade personally

Written by Your Future Now

The ratings downgrade South Africa received from S&P Global on 3 April is a big deal, as is evident from all the reaction it is still getting from politicians, economists, analysts and journalists.

For us ordinary people all this talk about the economy may seem really complicated and not all that relevant. So why should we care?

The truth is that it’s not all that complicated, and we should care, because the impact of the downgrade is real for all of us.

Let’s take a closer look.

 

What do ratings agencies do?

The role of ratings agencies is fairly simple when one compares them to credit bureaus.

Every one of us who has ever opened an account, had a credit card or taken out a loan, has a credit record at one or more credit bureaus. On that credit record your credit behaviour is recorded. Every time you miss a payment or pay late, it is noted. Similarly, all your good behaviours are documented.

Based on your credit history, you get a credit score. In ratings agency speak, this is a credit rating. Your score, or rating, is an indication of how likely you are to honour a debt agreement, and to repay a future loan on time and in full.

Every time you apply for a loan, or some other credit agreement such as renting a property, your credit score comes into play.

With a healthy credit score – which means you are a low-risk customer – you can negotiate the best possible interest rate and other favourable terms and conditions.

With a poor credit score, you basically have to accept what the other party offers you. In extreme cases, when your credit score is really bad, you won’t be able to get credit at all.

Ratings agencies play the same role, except that they rate countries, municipalities and/or companies.

Although the agencies look at other factors too, over and above a country’s credit behaviour, the outcome is essentially the same: they attach a score to the likelihood of the country being a good customer to whoever it borrows money from.

This score is used by entities from whom the country can borrow. These include other countries, institutions like the International Monetary Fund (IMF), and private entities like large pension funds.

When a country’s credit rating goes down, the cost of borrowing goes up – the same as in the case of a person. Lenders are likely to charge higher interest rates to make up for the fact that the country is a high-risk customer.

 

The implications of junk status

In view of what we’ve said above, it is clear that the recent downgrade has reduced the attractiveness of South Africa as an investment option. Consequently, the availability of investment has reduced and the cost of debt increased. In fact, in future 13 cents of every rand that we pay in tax will be used to pay the interest on our country’s debts. That is a lot of money that is no longer available for other things, such as service delivery, education, healthcare and roads.

But let’s take a step back and understand what is meant by “junk status”. Many investors have a minimum rating level. When a country or company receives a rating below this level, the investors are not allowed to invest in it anymore. Junk status is the laymen’s term for a rating that is lower than investment grade.

Given that the cost of credit will increase, the government will have to reduce its debt. The only way to do that, is to increase its income (which generally means higher taxes) or reduce its spending (which generally means less jobs or less service delivery).

It is also likely to impact our cost of living as basic needs and services are like to become more expensive.

What can we do?

Our country’s downgrade is a real and serious issue that demands action from us all.

As consumers, our first duty is to make sure our personal finances are as healthy as possible. We need to take a close look at our budgets, keep track of our expenses and reduce our own debt.

Article Categories:
economy

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