S&P’s decision to keep South Africa’s local currency rating at investment grade should allow the country some room to try to stabilise its rating, currently hovering just above sub-investment grade. Stabilising the rating is no small challenge, amidst elevated political and policy uncertainty and acute pressure on the fiscus, as tax revenue growth remains severely constrained by the lack of economic growth.
So says Old Mutual Investment Group Chief Economist, Rian le Roux, who warns that the risk remains that South Africa may still be subjected to further ratings downgrades – in a worst case scenario even a full-scale ratings meltdown, characterised by multiple downgrades by all the agencies.
“This implies that merely trying to avoid another downgrade over the coming months is not enough,” says Le Roux. ”South Africa must actively focus on correcting the issues that are undermining our investment grade rating, with the most immediate focus being to have the negative outlook changed to stable as soon as possible.”
All eyes now turn to Moody’s while they complete their 90 day review of South Africa’s economic situation. “We fully expect Moody’s to downgrade both the foreign and local currency rating by one notch, so still leaving both in investment grade, “Le Roux says.
“As we already know, if SA were to lose investment grade status on local currency government bonds from both Moody’s and S&P, we could be facing significant foreign investment outflows through forced selling of tracker global bond funds,” he explains.
“It is therefore indeed a relief that S&P decided to leave the crucial local currency bond rating unchanged at the lowest investment grade last week,” he adds. “Given that we expect Moody’s to have the same rating as S&P after their review, it provides SA with another brief reprieve to get its economic house in order. However, the reprieve will be short, as both agencies will revisit SA’s ratings within less than six months.”
Le Roux explains that significant uncertainty remains when it comes to the level of outflows we can expect should local bonds eventually be downgraded to non-investment grade. “Fund-related forced selling may actually attract discretionary buying owing to yield attraction,” he points out. “We know that foreigners own about R600billion of SA rand-denominated Government Bonds, but it is impossible to tell with certainty which part of this will be under forced selling pressure.”
However, as a developing country with a shortage of savings, Le Roux says that SA needs to be an enticing investment destination to attract foreign savings to assist with SA’s economic development. “The last thing SA can afford is to become a net exporter of capital. This remains a real risk over the medium term, an outcome that will severely dent SA’s medium term economic growth prospects” he says.
He adds that a flight of capital from SA will deal the economy a severe shock though various transmission mechanisms. “The most immediate will be a weaker rand, higher inflation and higher borrowing costs for government, business and consumers. But the shock dealt to business and investor confidence will be even greater and longer lasting, undermining the growth- and job creation potential of the economy” he explains.
Looking forward, Le Roux believes that the biggest economic threat facing SA over the medium term is moderate stagflation, i.e. sustained weak economic growth amidst sustained relatively elevated inflation. “Such an outcome will likely intensify fiscal, social and financial pressures and result in SA eventually losing its investment grade status by all agencies and on all classes of bonds, with all these potential ramifications,” he says..
“So, while the S&P reprieve is very welcome, SA has lots of work to do to fundamentally change course in order to get the economy on a higher growth path. The most important focus of government in the short term has to be on rebuilding business and investor confidence, a prerequisite for which will be greater policy certainty and predictability. Considerable uncertainties currently exist as to the practical policy implications of government’s Radical Economic Transformation agenda. Clarity is required urgently in order to stabilise confidence. In the absence of such certainty and a return of confidence, it is hard to see the economy moving to a structurally higher growth path any time soon,” he concludes.