Now is the moment to press reset on economy
By Mr. Leslie Maasdorp, Vice President and Chief Financial Officer of the New Development Bank
Published on April 12, 2020 by Sunday Times
The recent sovereign downgrade to junk status is a defining moment and turning point for SA. Combined with the potentially devastating economic shock induced by the coronavirus pandemic, this new reality represents the single biggest test for the country and its leadership in the democratic era.
The lockdown and effective shutting down of the economy overshadowed the news about the credit rating downgrade, but as a result of it SA is facing the Covid-19 pandemic in its most vulnerable economic state.
In December 2015, six months after I relocated to China as part of a team to establish the New Development Bank — an initiative of the Brics association of emerging economies — Brazil was downgraded to junk status. I saw first-hand how devastating the economic consequences of a downgrade to junk status can be — specifically, how swiftly the impact may be felt in the real economy by households and companies alike.
Within days of the downgrade, the Brazilian economy contracted into a deep recession that lasted for eight consecutive quarters, leading to untold misery for large numbers of people.
Defaults by companies led to large-scale retrenchments, fuelling unemployment and disrupting the lives of ordinary Brazilians in intolerable ways. Today, five years later, Brazil remains stuck in junk status, searching for ways to bounce back to a sustainable growth path.
History is not much of a guide to how long it takes to recover from junk status, as each country has its own context and conditions existing before its downgrade. However, besides some rare exceptions (South Korea 1997-1999 and Ireland 20112014), it takes, on average, up to seven years.
This is the first time since SA’s return to global markets in 1994 that we have had no investment-grade rating. SA is now considered junk on the credit spectrum by all three leading ratings agencies, namely S&P International, Fitch and Moody’s. In the words of SA’s National Treasury, “it could not have come at a worse time”. In the space of just a few days the economic outlook for SA shifted decisively, and looks bleak.
Credit ratings matter, since they are a measure of the creditworthiness of a country’s government. Ratings provide foreign investors with insights into the level of risk associated with investing in the debt of that country. With junk status, the message to investors is that SA’s debt has increased to such an extent that there is a prospect that the government may not have the resources to pay back what it has borrowed.
The timing of the downgrade revived questions in some quarters about the objectivity and judgments of the ratings agencies. After the 2008 global financial crisis, ratings agencies were widely criticised for giving highly favourable ratings to mortgage-backed securities, which almost brought the global financial system to its knees. As a result, the reputation of the agencies was severely dented. However, despite the agencies’ shortcomings, investors rely on this seal of approval and use the ratings as their guide. There is no opting out of this reality.
The key drivers behind the downgrade in SA are well known. In brief, the country has seen a slow and systematic erosion of its economic fundamentals over the past decade. The picture is not pretty and includes weak growth since the global financial crisis, an unsustainable rise in government debt, widening of the fiscal deficit, bailouts to loss-making state-owned enterprises, wasteful expenditure and corruption, and shortages in electricity supply, which in turn further depressed economic growth.
Against this backdrop, it is clear that the decisions by the credit ratings agencies to downgrade SA were backward-looking and retroactive, and had little to do with the onset of the Covid-19 pandemic.
As in Brazil, the downgrade will have material adverse consequences for every South African in all facets of our lives. As an immediate trigger, the rand dropped to an all-time low, below R19 to the US dollar. It is now only a matter of time before the spillover effects become real. No-one will be spared its consequences.
The country now faces the real prospect of a sustained recession locally, which will be made significantly worse by the new reality of a coming deep global recession.
The exact nature, size and duration of the economic downturn in SA remains unknown. However, the scale of the crisis is likely to be daunting and dependent on the pace of recovery of the world economy, over which SA has little to no influence.
If ever there was a moment to press the reset button, it is now. The reset will require a new mindset that no option can be ruled out to resuscitate the economy and sustain livelihoods. “Whatever it takes” has to be the new motto to guide leaders in the government, business, labour and civil society.
This includes exploring financial support from multilateral institutions such as the World Bank, International Monetary Fund, New Development Bank and others. They have been specifically set up to step in when countries face external macro shocks of this kind. At AAA or AA+ these multilateral development banks have the highest creditworthiness and thus the least expensive funding.
The most immediate task is to avoid a downward spiral into deeper junk territory. For starters, a credible economic recovery plan is urgently needed. To meet the basic standard of credibility, this plan — with clear timelines — should simultaneously accelerate structural reforms to stimulate growth, protect the vulnerable, preserve jobs at all costs and appeal to a sense of national solidarity across society.
The call for wage restraint in the public sector will remain hollow unless it is accompanied by shared sacrifice at all levels, including wage freezes and cuts in bonuses and other forms of excess in the private sector. Drastic measures are required, including companies withholding dividends to shore up their balance sheets in the interests of survival in the medium term.
The fundamental economic choices and trade-offs have never been starker. Several of the structural reforms will take many months and years to bear fruit.
To date, government efforts to suppress the spread of the pandemic have been unified, swift and decisive. The same resolve and capacity to take bold decisions are now required on the economic front. In President Cyril Ramaphosa, the country has a leader with vast, tried and tested experience in bringing the country back from the brink.
Furthermore, the country’s core economic leadership team of finance minister Tito Mboweni and Reserve Bank governor Lesetja Kganyago command the necessary credibility to drive and implement an economic recovery plan. Each is highly regarded by the ratings agencies and multilateral institutions, having had the benefit of working closely with them over a period of two decades.
Finally, the lockdown has laid bare and exposed the deep inequalities still prevalent in our society. Communities living in villages without running water and sanitation cannot be allowed to become a permanent feature of our society. Overcrowded townships where poor service delivery has become a normal feature in people’s lives are a stark reminder of the historical legacy of apartheid, which 25 years of democracy have not begun to erase.
We cannot go back to the way it was before. The question remains, what state will we be in when the clouds begin to clear?