South Africa Downgrade: Rating Agencies’ ‘Black Box’ Should Be Open To Scrutiny

By Kevin Mwanza Published: April 20, 2016, 7:03 am
Rating agenciesPhoto: Michael Gottschalk/Getty Images

Researchers at South Africa’s University of Pretoria want the methods used by global rating agencies, like Fitch and Standards & Poor’s (S&P), to be opened up to scrutiny, independent evaluation and validation.

According to Conrad Beyers, spokesperson for the group of researchers, the methodology that will be used by rating agencies to determine whether South Africa’s debt will fall into ‘junk status’ this year is a “black box” despite its huge ramifications.

“A ratings downgrade, especially in a highly publicized, controversial and politically loaded case such as South Africa, may result in a self-fulfilling prophecy effect,” Business Tech quoted Beyers saying.

Beyers said that a ratings status only reflects the view of a particular agency, and is based on their preferred model, subjective assumptions and decisions.

South Africa is currently at risk of being downgraded to non-investment grade ratings levels – also known as junk status – by several ratings agencies such as Fitch and S&P.

The country has been facing challenges mainly due to falling commodity prices on the global market that has hurt the country’s metal export revenue and a slowdown in the Chinese economy, its top trade partner.

Other challenges facing the most industrialized economy on the continent include a deteriorating political situation back at home, a weakening local currency, power outages and a ravaging drought that has seen food prices jump in recent months.

Riskier Assets

The imminent downgrade will make investors perceive debt instruments in the Africa’s second largest economy as riskier and hurt foreign direct inflows into the economy.

Beyers and his team said it will be “irresponsible” for rating agencies to use a shadowy calculator to make such a huge decision that may plunge countries with strong economic fundamentals into a negative spiral after the controversial downgrade.

The researchers argue that the potential downgrade might already have had a negative impact on the South African economy.

“Markets are forward looking and tend to react to what they think might happen in the future. Since the potential downgrade has been widely publicised, markets already started to reflect a possible downgrade,” said Beyers.

A Reuters report said in March that the expected junk rating was already being priced in by investors.

Recent data from the Johannesburg Stock exchange however showed that the country’s Treasury tripled its bond sale in the first three month of this year, compared to the same period last year, as investors regained confidence in South African institutions and in line with an emerging markets bull-run.

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