Two weeks after the cabinet reshuffle: Looking at the downgrade from an AGRICULTURAL perspective
18 April 2017
“The Cabinet reshuffle, which involved the replacement of the finance minister, Pravin Gordhan, and the deputy finance minister, Mcebisi Jonas, is likely to result in a change in the direction of economic policy ....” Jillian Green, Daily Maverick Managing Editor wrote on April 7, 2017 following the decision by President Zuma’s decision to reshuffle his cabinet.
Exactly a week after the reshuffle, a second rating agency, Fitch, announced on Friday April 7th that it downgraded South Africa’s long-term foreign and local credit rating from BBB- to BB+, which is classified as sub/non-investment grade - effectively taking the country’s investment status to ‘junk’. This follows Standard & Poor’s (S&P’s) decision on Monday April 3rd to downgrade South Africa’s sovereign credit rating to a similar rating status. Both S&P’s and Fitch cited current political events, which resulted to the reshuffle, as the major reason for their respective decisions to downgrade South Africa’s credit rating. In their view, they elieve current political event taking place in the country will weaken the standard of governance and public finances and ultimately lead to a change in the direction of economic policy which will undermine the progress that has been made in the last 12 months. During this period, there was a moment of economic stability in the country where the markets were responding positively to the fiscal order and discipline maintained by National Treasury especially curbing spending by the state-owned enterprises (SOE’s).
Being downgraded by two of the three major rating agencies (Moody’s being the third) means that South Africa is now generally consider as a ‘junk’ bond country by investors. Since the downgrade, financial stocks have lost billions and the local currency lost almost 10% of its value - moving closer to the (R14/$) mark as investors sold-off South African bonds. In addition, South African banks will also be impacted negatively by the downgrade in that in line with country’s downgrade, they have also been downgraded. In turn, this will make it more expensive for them to borrow money to lend out to individuals. This will effectively raise interest rate structure in the country at large, which will consequently dampen economic activities. On the other side, government will have to spend more money paying interest on its debt - meaning that it will have less available funds to spend on education, housing, infrastructure and social welfare - ultimately the poor are going to be the most adversely affect.
Currently, the economy is showing signs of recession as the country’s economic growth for 2017 has been revised to 0.2%. Unfortunately, this means unemployment rate is likely to increase further as the country will not be able to create new opportunities for employment, equally so companies, especially small businesses will be forced to cut down on their staff numbers and only keep those they see as highly productive. Typically, South Africa would have to grow its economy at least at a rate of 2% annually to be able to significantly reduce unemployment - as at the moment, this is a mammoth task something that is highly impossible.
Given this and the likelihood of interest rates hike in the months to come, the question is what will the downgrading mean for the South African agricultural sector which has been and remains a significant contributor to the country’s employment creation? Farmers that are export oriented are likely to benefit more from the depreciation of the local currency, provided there is an increase demand for their products from foreign buyers. Provided that South African agricultural export producers remain competitive in the international markets, a weaker rand can gain them a significant market share as their products will be view as cheaper relative to the products priced in stronger currencies. The resulting increases in sales of agricultural products abroad can improve South Africa’s agricultural economy and job creation in the sector.
On the other side, given that the economy is showing signs of slow growth while the rand continues a downward trajectory, demand for imports is likely to reduce quite significantly. One could argue that this will also benefit local producers because demand for locally produced agricultural products will increase. While this might be true, it will be short lived in the rand depreciates further. The depreciation of the rand may lead to higher cost of imports such as fertiliser and other agricultural inputs. Due to this inflation is likely to increases which will have an impact on food prices. Interest rates as mention earlier also likely to go up in the next few months - this increase the cost of debt for agricultural investors, both at farm level and along the rest of the agricultural value chain.
In 1994, when Nelson Mandela became president, South Africa’s credit rating was classified as ‘junk’ BB. It was only in 1999 that South Africa manage to be upgraded to an investment grading that in above ‘junk’ BBB- and ultimately reaching BBB+ in 2005 under President Thabo Mbeki’s leadership. Given that, it took five years to turn thing around then, one wonders how long will it take this time to turn things around.
Issued by Hamlet Hlomendlini, Chief Economist, Agri SA, 18 April 2017
