Like credit scores, sovereign credit ratings have become a common feature in the credit market and our daily lives. A sovereign credit rating is an assessment of a country’s creditworthiness or ability to repay its debt. The government borrows money from other institutions when government revenue is less than government expenditure. Simply put, there are three stages of credit rating: investment grade, sub-investment grade and non-investment grade. Investment-grade implies that a country will be able to repay its debt whereas sub-investment grade implies that a country might not be able to honour its debt obligations. Non-investment grade, also known as junk status, implies that a country is most likely to fail to settle its debt.
There are three credit rating agencies in the world namely, Moody’s, Standard and Poor and Fitch. These rating agencies consider several factors when rating a country’s ability to settle its debt. This includes the future growth path of the country, the country’s level of debt, debt maturity, interest payments and the degree of political stability. When a country is downgraded to “junk status”, there are several economic consequences for the individual and country as a whole.
Under Junk status, the government faces higher than normal interest rates when borrowing money from lenders as lenders try to account for the high-risk premium. This is because the government’s ability to repay the loan is limited. As a result, the government would face increased interest payments since the interest rate charged for the loan is high. As the government spends more money paying off the loan, the government will have less money to spend on social programmes (e.g., social grants) and infrastructure.
Also, the government’s ability to create jobs and deliver quality public services will be limited due to insufficient funds. Further on the downside, the government might raise taxes to compensate for the increase in spending. This will hurt individual taxpayers and companies as they will face a decline in disposable income (income after-tax). The effects of a downgrade go further to the exchange rate. As the country is downgraded to junk status, this translates into “bad publicity” for the country and as such, the exchange rate would depreciate, raising the price of imported goods such as petroleum oil. As a result, food prices will increase due to the increase in petrol price and consequently, transport costs.
A sustained increase in food prices will lead to inflation, thus placing pressure on the central bank (South African Reserve Bank) to increase the repo rate. When the central bank raises the repo rate, the cost of borrowing money at the bank increases, so does the interest charged on existing loans. Thus, the probability of citizens defaulting on their loan repayments increases, which to some extent, could create a shock in the financial sector.
Moreover, the increased cost of borrowing money discourages businesses from expanding and employing more people. This also serves as a barrier to business start-ups due to the high cost of borrowing. On the hindsight, the increase in the repo rate would be beneficial to ordinary citizens who would like to save or invest their money in the bank. An increase in the repo rate will lead to an increase in the bank deposit rate, thus making it beneficial to put money in the bank or any other financial institution. At a high level, the increase in the repo rate could foresee an increase in capital inflows to South Africa by foreign investors.
In short, junk status negatively affects ordinary South African citizens since they will be faced with higher food prices, higher interest on loans and a reduction in social spending and service delivery by the government.
Special thanks to Amogelang Basetsana Ratlhogo for her contribution in the article
