The recently confirmed stable and sound financial system by the Bank of Namibia and Namfisa will soon come under heavy pressure in the event of a South African rand downgrade. A downgrade in South Africa will put additional pressure on the stability and soundness of the financial system due to the close proximity and linkages between the two markets. In this regard, South Africa won’t be the only loser if it suffers another ratings downgrade as the consequences will go way beyond its borders and Namibia being within close proximity on many fronts (economic, political, monetary etc.) – it will be amongst the first casualties.
The meaning of junk status – a vicious cycle
If South Africa gets downgraded to junk status‚ which would be the next notch down‚ some global investment companies like pension funds and asset managers would be precluded from holding their debt because they have rules about how much risk they can take. The junk status effectively means a country becomes a risk for defaulting on its debt, because it might not have enough money to pay back what it has borrowed and the interest it has promised to pay the holders of its debt. It is a vicious cycle. If it gets downgraded‚ investors will begin to avoid investing there‚ the prices of its assets will drop because of the lack of demand for its debt and the shares listed on the Johannesburg Stock Exchange (JSE)‚ the rand will weaken further‚ inflation will shoot up and the average South African will have to endure higher costs for goods and higher interest rates.
Financial stability should be defended at all costs
A stable and sound financial system is critical to economic growth and prosperity and any threat or risk to it should be prevented at all cost. Prosperity being at the centre of Namibia’s economic agenda (Harambee Prosperity Plan – HPP) a clean bill of health for its financial system is indeed a welcome development and Namibia can’t afford any disturbances to its stability. According to the Financial Stability Report for 2015, Namibia’s financial system remained stable characterised by a sound, profitable and adequately capitalised banking sector with a relatively low level of Non-Performing Loans (NPLs). This condition is important for Namibia as it reflects a sound financial system. Furthermore, the clean bill of health is important for Namibia as it reinforces trust in the system and prevents phenomena such as a run on banks, which can destabilize an economy. For the man on the street, a sound financial system signals that his money is handled in a way which will not unduly jeopardise it. A sound and clean bill of health will therefore provide comfort especially for the saving individuals and corporates via contractual savings schemes.
Financial system will be affected via the contagion effect
When a rand downgrade occurs it will have a negative impact on the region at large because South Africa is an economic powerhouse. For Namibia, a downgrade will hit its financial system – which is closely linked to that of South Africa via the contagion effect. A contagion is a situation where a shock in a particular economy (South Africa) or region spreads out and affects others (Namibia) by way of price movements. Being part and parcel of the Common Monetary Area (CMA) and its currency pegging arrangement, Namibia’s financial prices are priced/benchmarked on their counterparts in South Africa and when a downgrade occurs those prices will be shocked and their reaction will be transmitted to Namibia’s products almost immediately.
A rand downgrade to exacerbate household and corporate indebtedness
South Africa is an important market for Namibia where commercial and corporates significantly go to for short and long-term funding needs. The market has served Namibia so well for a long time and supported the domestic financial market. A downgrade will cause the cost of funding in this market to rise and these will be transmitted over to Namibia. This will not augur well with the domestic and corporate debt levels that are already high – a key risk to financial system stability. According to the Financial Stability Report, the ratio of household indebtedness to disposable income at the end of December 2015 increased compared to the same period in 2014. Namibia’s household debt ratio was at 89.1 percent of disposable income during 2015 from 85.5 percent in 2014.
Capital flight is a major problem in Sub-Saharan Africa in general and Namibia in particular because it impacts negatively on capital scarcity. Capital flight has accelerated since early 2000, a period that coincides with the commodity-driven growth resurgence in Africa and has impacted on respective African countries’ financial systems. The impact of a rand downgrade in South Africa will also manifest in the form of capital outflows and potential spillovers to rand-denominated South African government debts. The outflow of capital from South Africa will create a shortage and disturb the financial market resulting in a rise in the cost of funding further. South Africa being an important market for Namibia – any increase in the cost of funding will be felt in Namibia as well. Capital shortage in South Africa as a result of a rand downgrade will then put tremendous pressure on Namibia’s financial sector as South African corporations strive to replenish the drying coffers by repatriating funds from Namibia and other countries where they have invested them before.
• Mally Likukela is Standard Bank’s Manager of Economic and Market Research.