Credit Ranking’s Future

Standard and Poor’s Financial Services downgraded South Africa’s credit ranking to junk status, BB+, after a cabinet reshuffle by President Jacob Zuma to replace Finance Minister Pravin Gordhan. The downgrade will undermine economic growth, fiscal policies and investment. This is a textbook example of how weak or unstable institutions, in this case the South African executive branch, can hinder economic growth and investment.

A BB+ ranking is S&P’s highest noninvestment grade mark. The most industrialized country in Africa will not only experience a halt in the inflow of foreign direct investment in addition to portfolio investment, but will also see more capital flight and depreciation with the impending Moody’s credit rating report coming out April 7.

This is the second time in less than two years that Zuma has shuffled or reshuffled his finance ministers, each time leaving investors with more uncertainty than the last, and each time inflating the rand against the dollar more. African political institutions have gotten better over the years by privatizing their economies and making legal attempts to isolate them from political spheres and institutions. However, there is no sign that in the future, African economies will be at the very least independent or less vulnerable to political instability.  For now, investors in the west are safe. When developing markets don’t pan out, investors have the option of returning back to the West or redistributing their money across the world to safe and well-trusted assets.

This tactic will soon be ineffective, as population projections show us that only a select number of economic centers in the world will experience exponential growth like that seen in the West in the past few decades. The western market will continue to age and become saturated with products and technologies, causing this demand to reach full capacity in terms of consumption. As a result, investors will have to look increasingly toward the developing world for new consumers.

Unfortunately, all the high-risk and high-reward markets that will drive consumer demands in the next 30 years either have infantile, weak or corrupt political institutions. This will heighten the risk factor in their markets in addition to the natural risk already extant for individual commodities.

With a limited number of high-growth markets, investors seeking high returns will have to invest in these countries with BB credit ratings despite the risks.

By 2050, world demand will have shifted to these high-risk markets and investors seeking high returns would have to strengthen infantile, weak or corrupt institutions. However, with the success of lobbying in the United States, all investors have to do is make sure they have the right candidate on the stand to reduce significantly the uncertainty and doubt in their markets when a cabinet shuffle or shift occurs. As a result, they may not be willing to spend the effort to stabilize political institutions in developing countries.

The devaluing of the South African rand and the increased risk factor of South African portfolios speak not only to the vulnerability of developing economies to slight political modifications but also to the asymmetric information that results from using the same metrics to measure the investment risk factor for a stable economy that has been industrialized over a century and applying it to a country that has only been independent for a quarter of a century.

As demand and investment opportunities shift and become more selective due to population dynamic changes, western investors will find themselves being pointed to areas that traditional S&P metrics rate as BB+.

Without the readjustment of credit evaluation matrices, it will not be surprising that the most industrialized country in Africa is rated as a non-investment category, and, consequently, investors will lose more money and opportunities as the asymmetry increases.

 

A10_columnist_MercyRadithupa

Mercy Radithupa is a sophomore in the McDonough School of Business. BUSINESS    OUTSIDER appears every other Friday.

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