Moody’s Investors Service, the last remaining credit ratings agency to hold SA at investment grade, has warned that rising income inequality could curtail growth, potentially compromising a country’s credit profiles.

In a report published last week, Moody’s said high inequality tends to be associated with higher levels of corruption and weaker government institutions — factors that can undermine overall institutional strength.

Moody’s highlighted IMF research that shows high income inequality negatively affects growth through the effect it has on health and education. It also finds that inequality, when it fuels economic, financial and political crises, can reduce growth by reducing investment and can lead to policies, such as protectionist measures, that dampen long-term growth.

However, Moody’s emphasised that its report does not amount to  a credit rating action.

In March, the ratings agency skipped SA’s scheduled rating review, keeping the country’s debt at Baa3, the last rung of investment grade. Should Moody’s downgrade SA’s credit status, SA would fall out of international bond indices, which would trigger automatic selling by institutional investors.

This would further undermine government efforts to address the triple challenge of unemployment, inequality and poverty, amid anaemic economic growth.

In its report, Moody’s pointed out that high and rising income inequality can, in certain circumstances, be an important influence on growth. In the case of SA, for example, inequality is highly relevant to the country’s economic strength and credit profile.

Moody’s noted that SA has the highest reported income inequality worldwide, and inequality in the country has increased over  the past decade, where it has decreased in emerging markets more broadly.

Referring to SA, Moody’s said slow growth is largely the result of domestic constraints, including a long history of political tension — itself partly a result of high levels of inequality — and structural rigidities that have undermined the willingness of businesses to invest.

“One consequence of those structural problems — high structural unemployment and high levels of poverty — is that in turn they fuel income inequality, as well as reducing human capital and weakening the country’s productive base. Income inequality constrains growth potential by contributing to structural weaknesses.

“That said, income inequality is not always associated with low growth, and in some cases faster growth may lead to an increase in inequality. The credit implications of high or rising income inequality for sovereigns are more limited when most incomes continue to rise, independent of changes in income distribution,” the report said.

According to the authors, the greater the income inequality, the lower the sovereign rating tends to be on average but variations around this relationship are large. Some low-rated sovereigns have low income inequality — for example, Greece (B1 stable), Egypt (B2 stable) and Belarus (B3 stable). In contrast, some highly rated sovereigns have relatively high income inequality. In all these cases, a range of factors other than income inequality determined the rating, Moody’s said.

According to the report, income inequality is highest in Latin America, Sub-Saharan Africa and India. With the exception of the US, advanced economies tend to have more equal income distribution than do emerging markets. Among emerging markets, East European sovereigns are the only group with consistently low levels of inequality, as a result of decades of communist rule that prioritised equal income distribution, the report stated.