• Tanya van Lill, SAVCA CEO; Langa Madonko

Moody’s downgrade calls for immediate structural reform

What began as a health crisis that triggered a financial crisis, the COVID-19 pandemic is quickly developing into a full-blown global economic crisis. For South Africa, the recent credit downgrade by ratings agency Moody’s to junk status has raised further concerns around the country’s economic position over the coming months.

While private equity (PE) and venture capital (VC) investors are specialists in managing the unexpected, the COVID-19 crisis is unprecedented in the scale of challenges it poses to the economy. The South African Venture Capital and Private Equity Association (SAVCA) therefore trusts that fund managers are working tirelessly with their investee companies during this critical time.

SAVCA board member and Investment Principal at Summit Africa, Langa Madonko believes that while the downgrade may not have an immediate impact on the economy, it will slow investment into the country over the medium-to-long term.

“As we are now deemed sub-investment grade by most large lenders and will only attract high-yield investors, the government will have to pay more for its debt from global markets. This will most likely affect social spending and infrastructure spend in the country,” Madonko says.

Madonko’s outlook is that the economy will have to be restructured in order to have a fighting chance at recovery. “We must reduce offshore investment allowances to 10%, and provide investment incentives into key sectors through unlisted, infrastructure and strategic investment vehicles. We also need to re-model social grants and their distribution, trim government spending, and promote beneficiation and processing of raw materials in South Africa,” he advises.

At the core of it all, Madonko emphasises that South Africa will need more Small, Medium and Micro-sized Enterprise (SMME) funding to revitalise and revive the economy and stimulate growth.

Echoing these sentiments, SAVCA member and Partner at Identity Fund Managers, Janice Johnston says that government should look to public-private initiatives to help grow the economy. “This is an important inflection point for government to consider a wide range of structural reforms in the economy, and potentially provide greater incentives for public-private initiatives to accelerate key infrastructure and service delivery investments and stimulate economic growth,” she says.

Johnston believes that Moody’s downgrade will still have a significant impact, given that South Africa currently runs at a large budget deficit. “The downgrade impacts government’s funding options as the direct cost of borrowing increases, due to the increased risk associated to the debt as reflected in the reduced credit rating. This will impact the fixed income and currency markets.

“In addition it will have an indirect impact on the equity market resulting from deteriorating investor sentiment,” she says.

Johnston notes, however, that the Southern African PE and VC industry is well regulated and has a strong track record in delivering competitive returns by highly experienced fund managers with robust standards of corporate governance. “It is a complex and diverse industry that spans a wide range of sectors, including those that are likely to be more resilient in an economic downturn, such as healthcare, education, infrastructure and agriculture.

“The PE fund construct is also a useful vehicle to facilitate important potential future public-private initiatives to enhance economic growth and job creation,” she adds.

On the topic of resilient sectors, SAVCA member and Partner at Webber Wentzel, Michael Denenga points to the country’s increased reliance on technology during this time. “Technology will be a critical driver for all companies if they are to weather the storm and grow the economy. Singular technology platforms that allow people to work from home and reduce costs will be key, and government has to do all it can to reduce data costs and support faster broadband infrastructure.

“More than ever, government must collaborate and consult with businesses before implementing any new regulations. The Conduct of Financial Institutions Bill should be enacted soon to provide certainty on the conduct requirements expected from PE and VC firms which are currently dealt with by various pieces of legislation,” Denenga advises.

With regards to what lies ahead for the private sector, independent economist, Jason Muscat – who recently spoke at a SAVCA webinar – says that businesses should try to plan for cash flow sustainability over 12 to 18 months. “That being said, with clinical trials being expedited globally and the rules for testing having been made more flexible, a cure or vaccine may be discovered sooner than anticipated, which would trigger an immediate snapback of financial markets and see developed market capital pour back into emerging markets.”

Regardless of when this happens, however, Muscat notes that the impact of COVID-19 and the downgrade may be mild for some companies, but incapacitating for others. “The businesses that will be hardest hit by COVID-19 will be those involved in tourism, entertainment and durable goods such as cars and furniture.”