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Analysis of S&P and Moody’s ratings announcement

28 November 2017 Kevin Lings, STANLIB Chief Economist

While many analysts expected S&P to downgrade South Africa’s local currency credit rating by one notch given the recent deterioration in public finances highlighted in the Medium-Term Budget Policy Statement as well as sustained low economic growth and ongoing difficulties at state-owned enterprises, almost no-one expected a downgrade to both SA’s domestic and foreign currency credit rating.

S&P cut South Africa’s international credit rating one notch from BB+, already sub-investment grade to BB. And its local current credit rating one notch from BBB-, investment grade, to BB+, sub-investment grade, sometimes referred to as “junk status”.

Moody’s was widely feared to be considering a one-notch downgrade as well so its decision to keep the country’s credit rating on hold at Baa3 means that for now at least South Africa remains at investment grade, although “with a view to downgrade.”

Here are the positives, negatives and warnings highlighted in the reviews:

S&P negatives:

• South Africa’s economic outlook and public finances have deteriorated further from the previous review in April.
• Economic decisions in recent years have focused on the distribution rather than the growth of national income.
• As a consequence, the economy has stagnated and external competitiveness has eroded.
• SA’s economic growth is the weakest of emerging markets countries, with less than zero per capita growth.
• Other than an absence of investment, S&P believes SA’s high unemployment is a function of an inflexible labour market with rigid wage-setting mechanisms and high barriers to entry and exit.
• This mix, alongside an inadequate education system, has contributed to the country’s stark inequalities and is a factor in its eroding competitiveness.

S&P positives:

• SA’s government debt is overwhelmingly rand-denominated. Only 10% is in foreign currency. This shields public finances from exchange rate shocks that in other emerging markets have sometimes triggered a debt spiral based on a weakening currency.
• Nevertheless, over half of SA’s central government debt is external given that non-residents hold close to 42% of the government’s rand-denominated debt.
• The high presence of international investors in the local debt market helps improve liquidity. But this does mean that government’s financing costs are vulnerable to foreign investor sentiment.
• A key credit strength is SA’s monetary flexibility, in that it has deep financial markets and a freely floating exchange rate, which gives the South African Reserve Bank flexibility to change monetary policy in response to prevailing economic circumstances.
• Political stability could resurface following the ANC’s elective conference in December. This would allow the government to focus on improving economic growth and stabilising public finances.
• S&P does not expect the country’s credit metrics to change substantially next year, that is they are unlikely to weaken considerably.

Moody’s warnings:

• SA on review for a downgrade, likely to take place in February 2018 unless government can show a willingness and ability to respond to the rising economic and fiscal pressure.
• Moody’s will be judging whether or not the authorities are able to implement growth-supportive fiscal adjustments that raise revenues and contain expenditure.
• Improvements to state-owned enterprises that contain contingent liabilities must be evident.
Moody’s negatives:
• If there is insufficient evidence of government implementing the necessary economic reforms in the next few months, Moody’s will likely downgrade SA to junk in the first few months of 2018.
• The Medium-Term Budget Policy Statement did not set out the measures that would be taken to address the additional fiscal pressures.
• Low investor confidence and limited progress on structural reforms are rooted in the uncertainty created by the fluid and unpredictable political environment.
• Unclear and shifting policy objectives, political manoeuvring and frequent changes of leadership in key ministries have weakened SA’s economy, finances and institutions.

Moody’s positives:

• SA has deep domestic financial markets and a well-capitalised banking sector.
• The macroeconomic framework is well developed.
• Foreign currency debt is low.
• Continued adherence to the constitution and the rule of law is a pillar of strength for SA’s institutions.

Unless government is able to meaningfully encourage private sector investment that leads to higher economic growth and an improvement in government finances, Moody’s will be forced to downgrade South Africa to below investment grade. This would have very significant implications for South Africa’s ability to attract sufficient foreign investment cost effectively and on a sustained basis.

Without sustained foreign investment that is cost effective, the country will perpetually struggle to achieve the growth rates needed to meaningfully reduce the level of unemployment and address the rising levels of social discord.


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