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Is the impact of the potential junk-status rating for South Africa over exaggerated?

Posted By IRMSAInsight, 14 March 2016

14 March 2016 


Is the impact of the potential junk-status rating for South Africa over exaggerated?


In spite of the high publicity in recent months, some analysts such as François Conradie from NKC African Economics believe that the current drought that has impacted most of the country will have a far bigger effect on the economy than a junk-status credit rating. A sovereign-risk ratings downgrade is likely this year but a big exit of capital and investment on the back of a downgrade is unlikely because the downgrade has already been priced into bond yields. It is anticipated however that the drought will result in poor harvests next year, even if rainfall increases suddenly, because the higher costs of agricultural inputs will make it difficult for farmers to plant. 


Read more on this article: Junk-status rating for SA not a big deal, say risk analysts


As a risk manager, have you asked yourself these questions?

  • Do you understand and are you able to clarify to your management team the link between your organisation’s risk exposure and credit ratings completed by rating agencies such as S&P?
  • Are you actively analysing and reporting what the impact of potential downgrades for South Africa will be for your organisation?
  • Are you considering possible scenarios should the drought continue?






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Philip Van Schalkwyk says...
Posted 14 March 2016
First, a very interesting article, however, there is a definite gap as to the effect a down grading will have on other players in the financial services industry.

Here I would specifically refer you to the case of an Africa (be it South Africa) registered re-insurer doing business outside its main country of registration.

An Africa domiciled re-insurer will almost certainly earn the majority of it's income from the country of registration, and a minority of it's business will be sourced potentially from other jurisdictions.

Due to the main source of business being the country of registration, that re-insurer's credit rating will be directly tied to the sovereign rating of the country.

The only way to get a rating above the sovereign rating of the country is to get the majority of business from other countries, or to have a parent company with a better rating who is willing to give a guarantee to the local entity (as happened for Munich Re SA recently).

Thus, if you do not have a rich parent, you are tied to the fortunes of the country, no matter what you do.

Doing re-insurance business in any other country, local regulators will require you to have a minimum credit rating.

So, as an example Company X, a re-insurer registered in South Africa, with the majority of it's business originating in South Africa, has a credit rating limited to the same as the country sovereign rating for South Africa.

With this rating it is able to do business in for example Ghana, Kenya, Tanzania, Namibia, etc.

However, if the sovereign rating for South Africa is downgraded to junk, the credit rating of Company X is immediately downgraded to junk as well.

Suddenly it finds itself in a situation where it can no longer do business in the regional countries it previously could.

This has 3 immediate impacts:
1. Whatever percentage of business that came from outside South Africa is lost immediately,
2. Because it now has to extract from contracts previously entered into, it has to do significant transfers of reinsurance portfolio flows, which in turn hits the bottom line immediately, and
3. Finally it's future is not tied to South Africa and South Africa alone, as it can no longer do any business outside of South Africa, not by any fault of it's own.

Yes, drought is going to hurt the normal economy that we all think of first badly, but there are secondary economies that will suffer a double effect of both the drought and a potential down-grading.
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