Ratings agencies Standard and Poor’s (S&P) and Fitch Ratings have both recently downgraded South Africa’s sovereign credit rating to junk status, which, based on the simple mantra of higher risk equals higher return, means that both existing and new funds borrowed by South Africa will become more expensive.
The knock-on effect of this will be that lending and seeking loans will become more costly for both South African consumers and businesses as interest rates and costs rise to adapt to this new volatile economic environment.
Mark Paper, chief operating officer at Business Partners International, says that when looking at how the increased cost of borrowing for South Africa will impact local small and medium enterprises (SMEs), he explains that local businesses will feel the ripple effects from the increased burden placed on domestic banks, including their ability to service foreign currency obligations, as a result of the recent downgrades.
“The South African banks are directly impacted by South Africa’s sovereign credit rating and as a result of the downgrade to junk status, S&P also downgraded South African banks to junk status.
“Thus an increase in borrowing costs by the domestic banks will, over time, put pressure on shareholder return. In order to bolster this return, banks will be forced to increase the cost of funds while reducing operating expenses – both impacting on the South African SME ability to obtain and service loans.”
The effect on consumers
He further explains that these factors can be expected to have a ripple-effect for consumers, who in light of increased interest rates, and rising prices, will have less disposable income. “These are all factors that influence the health of a small business’ cash flow at the end of the day,” he says.
While investing in South Africa is deemed to be riskier than it was a week ago, Paper says that this shouldn’t deter SMEs from investing in their business and contributing to the country’s economic recovery.
While faced with these uncertain times, it doesn’t mean that SMEs should suspend activity, or stop moving forward. Borrowing money, in good or bad times, can make a lot of business sense for well-managed companies.
He stresses that in these uncertain times, there are several factors to consider when managing existing debt or seeking new funding.
Understand your funding needs
“SMEs need to ensure that they understand the funding options that exist, as well as what type of funding is best suited to their needs – be it equity, long-term debt for fixed assets or shorter-term working capital – as this will determine who to approach, the term and price to pay, and what impact this will have on the business’ cash flow.”
SMEs should also be encouraged to seek expert advice prior to obtaining new funding. “By speaking to a financier who not only offers the right type of funding, but who also understands the business and the challenges likely to be faced in these uncertain times, will enable the business owner to be realistic about short- and long-term cash flow projection.”
Focus on improving performance
Paper also advises SMEs to relook at their business plan and review ways in which they could improve performance. “SMEs should get back to the basics of focusing on the selling the right product or service at the right price and not chasing turnover for turnover’s sake.”
If SMEs are providing credit terms to customers, Paper adds that business owners should have more emphasis on handling their debtors promptly and professionally to ensure their cash flow is not affected when it is needed. “Every business has its share of slow-paying and non-paying customers. Bad debt is a problem for businesses of all sizes. This position is made even worse during difficult economic times, especially for a small business where one non-paying customer may be the difference between survival and failure.”
Looking to the rest of the year, in anticipation of whether the country will face further downgrades from S&P or be downgraded to junk by Moody’s, Paper says that BUSINESS/PARTNERS won’t alter its approach to financing SMEs. “We remain committed to serving SMEs, throughout the good and the bad times, and regardless of the current economic environment.
Junk status means we need entrepreneurs more than ever
Paper adds that now more than ever, South Africa should be backing entrepreneurs. The Entrepreneurial Ecosystem of South Africa: A Strategy for Global Leadership Report by Global Entrepreneurship and Development Institute (GEDI) states that by improving entrepreneurial conditions by just 10%, $176-billion could be added to the South African economy.
“Creating an enabling conducive environment for SMEs will always go a long way in helping more businesses grow and will add to the overall success of the country’s economy. It is therefore crucial, particularly in trying economic times, that South Africa creates an enabling environment which supports business’ ability to transact,” concludes Paper.