the poorer households who, unlike the wealthier ones, do not have the possibility of ‘ hedging themselves ’ from the consequences of a downgrade by diversifying their assets. there are five major channels through which the recent rating downgrades can undermine the well - being of poorer households, which i will discuss more in detail. page 2 of 10 the ratings of a listed entity ( be it a government or a corporation ) are meant to reflect its ‘ credit quality ’. hence, they are used by international investors to gauge the risk of buying the bonds issued by that entity. in theory, therefore, these investors will – subsequent to a downgrade – require a premium in the form of a higher interest rate, or they will shun these bonds altogether. south africa requires foreign investors to finance its external deficit ( as its imports regularly exceed its exports ). a rating downgrade therefore means that financial markets will move to a new equilibrium where the interest rates on bonds are higher and the exchange rate of the rand is weaker than before the downgrade. obviously, the recent empirical evidence is clouded by the fact that many other factors, bar sovereign ratings, influence the price of south african financial assets. nonetheless, a standard measure of sovereign credit risk for south africa, namely the credit default swap ( cds ) spread, has underperformed compared to its emerging - market peers in recent years, and is now trading at similar levels to non - investment - grade countries. this is clear evidence that investors are requiring a higher risk premium, if only in relative terms, on south african government debt. the increase in the yield on inflation - linked bonds issued by national treasury, over the past two to three years, is another such indication. even after being fully protected against inflation, bond investors require a higher return – even as global economic factors have continued to depress risk - free, real interest rates all over the world. these higher yields on south african bonds will, over time, negatively affect the poor. as the south african government faces a higher cost of borrowing, it will have to devote a larger share of its ( finite ) resources to page 3 of 10 servicing debt. already, estimates by national treasury indicate that government debt - servicing costs are expected to represent 10. 4 % of total budget spending ( and 3. 5 % of gdp1 ) in 2017 / 18, up from a low of 7. 0 % in 2009 / 10. this stands in contrast to the years prior to the global financial

2014. as for the rand, it has recovered by about 20 % on a tradeweighted basis from the lows it had reached in early 2016. yet this relative stability is fragile, dependent on developments that may reverse in the not - too - distant future. the lack of a strong sell - off in either the rand or local bonds has more to do with a conjunction of favourable international factors than with investors downplaying the possible negative consequences of a downgrade. in particular, the factors referred to are the improvements in global economic developments, the absence of inflationary pressures in the advanced economies, and a stillaccommodative stance by the world ’ s major central banks. these factors have ensured that capital continues to flow to the emerging world, even to countries which have experienced a deterioration in their creditworthiness. but these flows could easily reverse. and amid tighter global financial conditions, investors would be more likely to differentiate between stronger and weaker sovereign credits. should south africa face another global shock, like it did during the 2008 - 09 global recession, its page 8 of 10 recent rating downgrades could well make it more vulnerable to that shock. admittedly, some commentators claim that further downgrades to south africa ’ s sovereign ratings would not starve the country of foreign capital, as other investors – specifically, funds of a more speculative nature – would still buy domestic financial assets. however, apart from the fact that these investors would require a higher return on south african assets than recent historical norms, their investments would be more short - term in nature, most likely resulting in a higher volatility of market prices. this, in turn, would increase the climate of uncertainty facing domestic businesses, with negative consequences for fixed investment, job creation, and therefore poverty and inequality. in conclusion, let me say that a sovereign rating is not a policy goal per se. rather, it is a reflection of a broad range of economic, social, and political factors that constitute the creditworthiness of a country. key among these factors is the strength of our institutions, including the chapter 9 institutions, the judiciary, and the south african reserve bank. these institutions underpin our democracy and our creditworthiness. it is this creditworthiness that policymakers should strive to improve, for goals that include development and poverty reduction. as international experience shows, it is failure to generate sufficient economic growth and to maintain healthy fiscal and external balances that keeps large portions of a country ’ s population in