Myth and misinterpretation muddy the ratings agency waters
Methodologies differ and momentous events such as Cyril Ramaphosa’s ascendancy do change the picture
We’ve been down the ratings downgrade path for a long time now. So let’s lay down some lessons we’ve learnt along the way.
We know a sovereign credit rating is an independent assessment of a government’s creditworthiness — that is its ability to repay debt — and thus the rating assigned indicates how risky it is to invest in a government.
We also know there are three main ratings agencies: Moody’s, S&P Global Ratings and Fitch. Each has its unique methodology for assigning sovereign credit ratings. Agencies are similar in that they’re generally assessing the same thing, and hence eventually get to more or less the same outcome. But the time it takes for each agency to get there can vary considerably.
We know SA is assigned a subinvestment grade rating from S&P and Fitch, but Moody’s rating remains investment grade, though only by one notch. And we’ve all come to know there is a process of assigning a credit rating: a stable outlook can remain indefinitely, but when a negative outlook is assigned it signals that the next likely direction for the rating is downwards within a 12-18 month window unless the required improvements are made to the country’s creditworthiness.
There are nuances. A common one is that a country can also be placed on “rating review” (or “credit watch list”) when it is on review for a possible downgrade, which is typically resolved within 90 days.
When a lead analyst is based in the EU (like Moody’s) we know the agency is required to publish a sovereign release annual calendar with two dates for the potential release of ratings actions. But regardless of these dates, they don’t have to review if they do not deem it necessary.
And finally, we know why this matters: a Moody’s downgrade would immediately remove SA from the FTSE World Government Bond index (WGBI) and the currency would weaken; by how much remains debatable but in the end we lose investment. In addition to the WGBI, a fully junk status is an obvious negative for the economy — fixed investment in particular.
Those who follow ratings agency decisions closely are aware that the downgrade cycle started way back in 2012. And while it is often said that S&P has been “ahead of the curve”, Moody’s was actually the first mover, downgrading in September 2012 from A3 to Baa1 (though S&P moved soon after). The Moody’s 2012 downgrade decision was based on three main issues: a decline in institutional strength ahead of then president Jacob Zuma’s soon to be second term, a negative investment climate, and concerns about future political stability. In hindsight, Moody’s was spot on.
Both agencies continued to downgrade three times each, broadly in tandem, until 2017. This is when S&P finally downgraded the rating to what is colloquially known as “junk” (subinvestment grade) whereas Moody’s placed the country on a rating review. But during the allocated time Moody’s took to resolve this review Cyril Ramaphosa replaced Zuma as president. A change in government, for the better, is arguably the most powerful shift a country can experience, and Moody’s therefore assigned a stable outlook. But because S&P got to “junk” first it is now seen to be the “front-runner”.
Therein lies the rub. For a country that focused more keenly on S&P’s sovereign ratings decision, did we not become overly conditioned to S&P’s methodology, forgetting that agency methodologies differ and therefore the timing of their decisions can differ? Have we forgotten the momentous political event that occurred in 2017 between the S&P decision and Moody’s decision? And are we not just tired of waiting for Moody’s to do what many believe is the inevitable?
It may sound like I’m defending Moody’s and its seemingly “generous” assessment of SA’s creditworthiness, but in fact I’m simply trying to be as impartial as possible, considering both the nuances of the methodologies and the rapidly changing political environment since 2017.
It seems easy to deem SA worthy of another Moody’s downgrade to junk, but the agency does not base its decisions on S&P’s methodology, nor does it base its decision on how weary those monitoring the situation may have become. And what many forget is that institutional strength is just as important a factor as economic strength and fiscal strength in Moody’s methodology. Therefore, the change in government from Zuma to Ramaphosa really was a big deal.
But let’s fast track to where we are today and note that the last time Moody’s did an official credit review was March 2018. The agency skipped its November 2018 and March 2019 review dates, though as mentioned earlier this is absolutely within the realm of possibilities. I so often hear comments such as, “they should just do it already” or “they are so generous”, yet a deeper assessment of why Moody’s has not yet changed anything seems lost in the discussion. To make matters worse, frequent misinterpretation of how Moody’s processes work doesn’t help.
The recent celebration that SA has somehow avoided a ratings downgrade in 2019 is exactly that: misinterpretation. SA is on a stable outlook, which means the worst that can happen at the scheduled November 1 Moody’s review is either a negative outlook (which is not a downgrade) or a rating review (which is not a downgrade either). Both potential decisions are strong warnings that a rating downgrade is imminent, but both come with timelines of 12-18 months and 90 days, respectively. A small window therefore remains for the government to improve the situation, which is exactly what happened between November 2017 and March 2018.
The big difference now is that the stable outlook decision in March 2018 was because of something momentous — a change in the presidency. This time around we need something just as momentous, but in the form of fiscal and economic strength.
It is not a relief that a downgrade is off the table in 2019 because it was never a reasonable possibility to begin with. But a negative outlook is a real possibility and it’s a slippery slope to a downgrade thereafter. The government needs to act very quickly.
• Schoeman is Citibank economist.