Financial advice in a junk status economy

There are endless repercussions of our recent downgrade to junk investment status, but it is important to understand how this will impact the lives of average South Africans. In the first instance, consumers should be cautioned against anticipating an immediate economic reaction to a credit rating downgrade. A downgrade essentially sets off a chain of events which will have a cumulative impact on South Africa over a period of time that can have devastating consequences. Akin to fracturing a limb, there may be no immediate visible damage to the economy, but there is undoubtedly hidden structural damage that will manifest over time. As opposed to a single event, a credit rating downgrade is essentially a series of events that are triggered and which, as history has shown, follow a natural progression.

Rather than adopting a reactionary approach to the political or economic storm of the day, we believe that proactively gearing one’s finances for what can reasonably be expected to happen in the months (and years) following a downgrade is a more prudent fiscal approach. Up until, and immediately after, the 2019 elections we can reasonably anticipate some political uncertainty, making this an opportune time to fortify one’s financial plan against medium-term increases in interest and inflation.

South Africa’s recent downgrade to junk status means that the SA government will have to pay more to service its debt which it can do by either reducing expenditure or raising taxes. This creates an enormous burden on our National Treasury who will be under pressure to collect more taxes in the next financial year, having just introduced higher tax brackets for the super wealthy.

Historically, countries that are downgraded to junk status fall into a recession, and it is widely believed that South Africa will follow this trend as the country is not currently geared toward sustainable growth. This will place pressure on the South African Reserve Bank to review the repo rate upwards which, in turn, will increase payments on home loans, credit cards and other goods and services as consumers present a perceived greater risk of default. Although this will affect all South Africans, there remains an inherent element of inequality in that those people with a higher credit rating  (generally the affluent) are able to borrow at a cheaper rate than those with a lower credit rating (lower income earners).

With the potential for tax increases, interest rates hikes and salary freezes, middle class South Africans who are servicing home and vehicle loans will be hit hard. Being downgraded to junk status could conceivably mean that South Africans will be paying 2% or 3% more to service their debt which can have severe impact on the ability to live from month-to-month without incurring more debt. South Africa’s economy, which was predicted to grow at only 1% this year, is likely to slow down even further. Reduced economic growth has a knock-on effect on jobs, crime, infrastructure and the value of the Rand. Notably, a weaker Rand means higher transport costs, which effectively increases the price of everything that is transported by truck.

To protect oneself financially in a junk status economy, the reduction and elimination of short-term debt is absolutely essential. Because it is likely that lending rates will increase, it is advisable to pay-off short-term debt (credit card and retail accounts) as quickly as possible, and avoid incurring any new debt. Exercise caution before upgrading large cost items such as vehicles as even a 1% interest rate hike can dramatically impact on your monthly repayments.

One of the most effective buffers against future interest rates hikes is the creation of an emergency fund. Frighteningly, recent stats indicate that 69% of South Africans do not have any emergency funding in place. Although there is no rule of thumb, a meaningful emergency fund should be equivalent in value to between three and six month’s worth of earnings, and should ideally be housed in an easily accessible account. An emergency fund will help cushion the impact of future interest rates hikes and cost of living increases, and will help one avoid incurring further debt should unforeseeable expenses arise.

It is evident that the South African stock market had already factored in a downgrade and, as a result, the markets were not heavily impacted at the time of the announcement. This does not mean that the markets will not respond negatively over the medium-term, and this remains an opportune time to review your investment portfolio with an independent financial planner to ensure that your investments are diversified to protect against risk. As investors, we need to brace ourselves for a stagnant market in which there are fewer investors, more inflationary pressure, interest rate increases and economic tension.

Having said this, investment markets have proven that they have the ability to return to fundamentals even in the case of political unrest and economic instability. Despite recent events in South African politics, investors are cautioned against reacting emotively to the downgraded status and to remain invested at all costs. This is no time for speculation but rather a reminder that, if one is invested for the long-term, recent market volatility is within the acceptable confines of the normal patterns of equity markets.

Have a wonderful day.

Sue

 

Going forward, consumers who are already heavily burdened by unsecured debt, will be forced to cut back on discretionary expenditure.



Categories: Financial Planning

Tags: , , , , , , , , , , , , , , , , , , , , ,

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s