The decision by ratings agency Moody’s to downgrade South Africa’s sovereign’s credit rating to ‘junk’ may be the start of further downgrades in the coming months, say Nedbank economists.

“In our view, the risk that South Africa will be downgraded further down sub-investment grade remains, as domestic politics are still unlikely to create sufficient space for the sovereign to correct credit weakness and the full negative economic impact of Covid-19 is also uncertain,” the economists said in a research note published on Thursday (2 April).

Nedbank said that the government’s ability to mitigate the above risks is currently limited, as the fiscus is already under strong and widespread pressure, while monetary policy cannot address underlying structural economic issues.

“The decision to downgrade the credit rating was in response to the government’s constrained capacity to stimulate the economy in a period of low global and domestic growth, coupled with an unavoidable further rise in debt over the medium term at a pace faster than Moody’s had expected,” it said.

Moody’s cut its assessment of South Africa’s debt to sub-investment grade on Friday (27 March), saying unreliable electricity supply, persistent weak business confidence and investment, and long-standing structural labor market rigidities continue to constrain economic growth.

According to Moody’s the downgrade comes as South Africa is beaten down by unreliable electricity supply, with persistently weak business environment and low levels of investment.

The country also has a long-standing labour issue, and low levels of flexibility on policy. Effectively, South Africa has a lot of problems, and government isn’t (and can’t) move quickly enough to solve them.

While the coronavirus pandemic is mentioned in the report, the crux of the rating downgrade lies in the country’s other fundamentals.

“The decision by Moody’s could not have come at a worse time. South Africa, like many other countries, is seized with containing the outbreak of the coronavirus (Covid-19),” said Treasury.

“The impact of Covid-19 is felt across various sectors of the economy including the financial markets which experienced a significant sell-off in equities, bonds and exchange rates as investors retreated to safe haven securities amid the uncertainty.

The sovereign downgrade will further add to the prevailing financial market stress. These two events will truly test South African financial markets, it said.

“South Africa’s deep, stable financial sector and robust macroeconomic policy framework have always been flagged as a credit strength, including the South African Reserve Bank’s demonstration of a good track record in implementing credible and effective monetary policy and preserving financial stability.”

Read: South Africa is fully junked – what happens now?