The effect of a junk status on debt in SA

Finance Minister Pravin Gordhan reportedly stated that a credit ratings downgrade to junk status (non-investment grade) would have a negative impact on debt in South Africa. This is due to the significant increase in interest that would need to be repaid on these loans and debts.

Ian Wason, CEO of DebtBusters, said: “If South Africa gets downgraded to junk status this December, the impact on the South African consumer will be a negative one. The cost of consumer debt will likely increase making borrowing more expensive. This will put increased pressure on household budgets and drive more consumers into an over-indebted state.”

The impact of a credit ratings downgrade

John Loos, household and property sector strategist at First National Bank (FNB), explained: “The simple answer is that rating agencies provide indications to many investors on the level of risk of countries, in the case South Africa. A ratings downgrade, should it happen, means that the agencies would then see South Africa as a higher risk investment destination than was previously the case. Certain investors could take this as a signal to reduce their investment levels in South Africa, or other would-be investors may no longer be interested. Capital flows into South Africa could conceivably weaken while capital outflows could strengthen. The immediate result being a weakening in the Rand and higher imported cost inflation, which would feed into local consumer price inflation. The Reserve Bank may then be forced to act by raising interest rates, as containing inflation is its main target, raising the cost of repaying debt for those of that have floating interest rate debt (i.e. not fixed rates).”

According to Wason, if South Africa is downgraded to non-investment grade, this could negatively impact the value of the Rand and “will make trading with other countries expensive leading to consumer goods being expensive too.”

Loos agreed highlighting that a number of investment funds reportedly have policies in place to prevent them from investing in countries with a ‘junk status’. “Should SA be downgraded to junk status it is possible that the Rand impact could be quite severe, and that could affect the magnitude of interest rate hiking.”

The consumer

A credit rating downgrade will likely see the cost of living increase with a rise in living expenses. Loos noted that if foreign investment inflows reduce, this could impact on the country’s economic growth. In turn this would affect employment and household income growth, placing pressure on South African households.

Consumers who are dependent on debt will feel the effects of a downgrade, with Wason predicting an increase in debt counselling applications.

“Consumers need to be aware of the increasing cost of living and the costs of credit and align these with their income and their budgets. Once the debt spiral starts it is extremely difficult to get out and consumers are urged to seek the help of professionals,” highlighted Wason.

Loos added: “When it comes to containing expenditure, I think that many people try to “sweat the small stuff” instead of looking at the big purchases that are the cause of big ongoing expenditures. The “Big 2” I believe are the house and the car. Many of us zoom in on the immediate cost of buying these items. We are often bad at getting a handle on the long term recurring costs that are caused by the purchase of these items. They include various insurance, furnishing one’s new home, maintenance costs, municipal rates and taxes, and all this beside the possibility that interest rates can go up in future.

“If you are an aspirant home or vehicle buyer, or both, think very carefully about the “level” you buy in at. A smaller and cheaper home can reduce all those abovementioned ongoing costs dramatically, and the same is often true for cars. The same goes for various appliances and equipment that we accumulate over time. Many of these items come with maintenance and replacement costs.”

According to Loos, even though interest rates are relatively low, as many as 14% of total home sellers are believed to be selling to downgrade due to financial pressure. “In other words, a sizeable portion of homeowners have overcommitted financially on their home purchase. That is a very costly mistake to reverse (although one must reverse it if you can’t manage the costs incurred), because the various transaction-related costs associated with buying a home are high.”

Money in a zero-growth economy

Whether or not the country experiences a credit ratings downgrade in December, the South African Reserve Bank (SARB) has forecast no growth for the South African economy this year. FNB highlighted the strain this could place on consumers’ finances. There is the risk that some may prioritise wants over needs, including doing things such as selling a home and moving in with parents to afford luxuries, or cancelling important insurance policies.

Preenay Sathu, FNB financial advisory channel head, noted that the financial plan you implement when times are good, should be the same plan to see you through the tough times. “When it comes to money management you should always adopt a holistic approach with firm emphasis on your individual needs and goals. Adopt a goal-based financial planning approach to help you identify, articulate and prioritise your goals. This is then followed by an outcome-based investment strategy to help you achieve your stated financial goals over a specific time horizon.”

An important aspect of this is knowing the difference between for financial responsibilities, needs and wants. By knowing this you can build a picture of how to budget appropriately, according to Sathu. This includes knowing where to allocate discretionary or surplus income. “Sometimes this takes some serious introspection, but being honest with yourself is the cornerstone of ensuring that your approach to money management is rational and realistic.”

 Handy tip: If you are struggling with debt, debt counselling might be the option, you can apply here through Justmoney.