Beware the downgrade?

Should a downgrade occur, what will be the impact on costs and financing for the transport and logistics sector?

Since the beginning of 2017, many consumers and businesses have been wary of a possible total downgrade. This has resulted in depressed business and consumer confidence indicators, extending to concerns over the economic climate in the near future.

After the downgrade by S&P and Fitch in April, ratings of local banks followed suit. Bank ratings cannot be higher than the sovereign rating, which is why many global banks are headquartered in financially strong sovereigns, such as the United Kingdom.

It is widely understood that a further downgrade will prove disastrous for many sectors in a stagnant South African economy.

However, the impact across the transport and logistics sector is slightly more difficult to pick apart. It has been widely accepted that a full downgrade into junk status will result in a sharp depreciation of the rand, and a subsequent increase in the fuel price.

The cost of fuel as a share of total operating costs will rise at a time when the dollar oil price is being constrained by supply ceilings imposed by non-compliance at OPEC, and the emergence of United States shale oil.

Operators that exist on small margins will find it difficult to remain competitive if fuel prices constitute a higher percent of their operating budget.

In times like this, innovation and fleet replacement become essential – although difficult – tasks, especially when we have seen a decline in fixed investment limiting the demand for heavy commercial vehicles.

The second point of concern is financing a fleet, which remains a challenge that continues to trouble many transport operators. Following a downgrade financing becomes more difficult as credit repayments are likely to increase significantly as the repo rate shoots upward.

Our own forecast brings the prime rate trending consistently upward into 2019 (should a downgrade occur), when the economy should be in recovery territory. Operators existing on the margins may find it difficult to attract the required long-term financing with favourable rates.

In July the Reserve Bank announced it would be cutting the main repurchase rate that ultimately links to the cost of credit. Citing a lower inflation outlook, the cut in interest rate remains a welcome relief to operators during a difficult climate. The current, cheaper finance should encourage fleet operators to consider embarking on fleet replacement now – while interest rates appear to be moving in a positive direction.

Is there a shining light? Banks remain well capitalised and financially sound. The financial crisis of 2007 provided a lesson in the dangers of undercapitalised, illiquid financial institutions. South African banks have shown resilience and are sufficiently evolved to weather the short-term volatility that will occur should a further downgrade take place. This means the financing environment will not be too debilitating.

Finally, growth is expected to gain momentum during 2018. Operators with an eye on long-term fleet planning should not adopt a wait-and-see mentality until business confidence returns. The volatility experienced in 2017 may mean that business confidence takes longer to rebound.

Moody’s recently concluded a review, choosing an unchanged view on the institutional strength of key institutions in the South African economy. If there is commitment to fiscal discipline in the face of political pressure, the economy may well be on the path to recovery before too long.

SAM Rolland is an automotive and transport economist at Econometrix. He is responsible for writing the Quarterly Automotive Outlook at Econometrix, as well as commentary and analysis on vehicle sales and transport price drivers. Prior to joining Econometrix, Rolland spent a number of years as an economist for the National Treasury of South Africa. He has also worked at Bloomberg New Energy Finance as a research analyst in conventional power.