Downgrade could add R2.5bn to SA’s interest payments

The SA Reserve Bank this week estimated that the probable effect of a downgrade to “junk” status would be up to an extra 1% interest on foreign currency bonds.

In rands and cents, this could theoretically amount to about R2.5 billion in extra interest payments before any knock-on effects on the private sector.

The widespread expectation of a downgrade has, however, already pushed up yields on South African government bonds, especially following the firing of former finance minister Nhlanhla Nene.

“It seems logical to conclude that much of the downgrade expectation has been priced in by market actors,” said Chris Loewald, deputy head of policy development and research at the central bank.

“Yields have increased since the downgrade has been extensively discussed.

“The rands-and-cents effect of a rise in the yield will fall on new debt issued at the time,” said Loewald.

This means that when the interest rates Treasury has to promise in order to sell bonds rise, the new expensive rate only becomes effective as older debt is replaced over time.

Loewald, however, also observed that the second rands-and-cents effect is the higher income investors get from holding government bonds.

The central bank estimate in this week’s quarterly Monetary Policy Review was based on what happened to 70 other countries that had their bonds deemed subinvestment grade by Fitch Ratings.

Fitch is one of the three major international ratings agencies whose evaluations of governments and corporations’ creditworthiness play a large role in global capital markets.

“Based on these observations, a downgrade to below investment grade is likely to increase short-term rates by 80 basis points. Long-term yields would be expected to move more, rising by 104 basis points,” the Reserve Bank said.

One-hundred basis points is equal to 1 percentage point.

One percent would be R2.5 billion in extra annual interest payments if the new higher interest rate suddenly applied to all the foreign currency bonds South Africa has out there in the market.

In reality, it would take some time for the higher interest rates to take effect.