Economics

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Why does 'Junk bond status' matter for South Africa?

Penny Brooks

4th April 2017

As the calls for South Africa's President to step down from office gain ever more ground, it is worth looking beyond the simple 'corrupt leadership' view of development, and considering the possible effects. Standard and Poor's have downgraded the rating of the country's government bonds to 'Junk' status. What impact may this have on the economy for a country which, in spite of being a member of the G20, has over 30% of its population living in absolute poverty, and which has the fourth highest Gini coefficient in the world?

President Jacob Zuma was found in breach of the law by the constitutional court when he failed to repay government money spent on his private home. There are many allegations of corruption against him, which he has so far managed to overcome. As the BBC reports it, the present disquiet follows his unilateral sacking of respected Finance Minster Gordhan last week, which his Deputy President Cyril Ramaphosa called "totally unacceptable". The powerful Congress of South African Trade Unions (Cosatu), was not consulted about the decision and has said that he should go, as has the South African Communist Party and the ANC's integrity committee.

The BBC also reports that South Africa's economy has seen weak growth for a while, with growth at just 0.3% last year, and GDP per capita actually fell in 2016. They suggest that the only things preventing downgrading of the government bonds before now were

- confidence in former Finance Minister Pravin Gordhan,

- a knowledge that South Africa has strong institutions and a working democracy,

- it has a number of sectors which are among some of the best in the world, particularly mining and financial services.

As usual, it is important for economics students to look beyond political upheaval and accusations of corruption as constraints on development, and to analyse the economic implications. Here are some effects to consider:

The South African currency has immediately weakened. What effect does this have on imports and on cost-push inflation? What assumption is being made about PED in predicting that effect?

What is likely to happen to exports, and again, what assumption about PED underlies that expected effect?

How does the transmission mechanism suggest that the central bank, the Reserve Bank of South Africa, might react to rising inflation and why? Might the cause of the inflation (cost-push) make any difference to that response?

What effect might a rise in interest rates have on consumers, and on businesses? How might the very high degree of inequality in the country's population affect this?

Why would shares in South African banks have lost value since the Standard and Poor's downgrade?

If the other rating agencies Moody's or Fitch follow suit, big international investors like pension funds would be forced, under their own rules, to sell their South African government debt. What impact will this have on government bond yields, on government spending and on the government's budget?

This linked article will give clues to many of the answers to these questions. Students of development economics should then go on to consider policies that the government could use to establish faster growth, and recover confidence in the economy.

Penny Brooks

Formerly Head of Business and Economics and now Economics teacher, Business and Economics blogger and presenter for Tutor2u, and private tutor

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