South Africa is in the middle of controversies relating to the South African Revenue Service, the Hawks, the Minister of Finance, Pravin Gordhan, the National Treasury, and State-Owned Enterprises (SOEs). There are also serious tensions within the government and the ruling African National Congress. South African government bonds have lost money for investors as bond yields have increased. This could get worse if Gordhan is to be replaced by someone who is less trusted by investors. There are conflicts between the National Treasury and the SOEs (for instance Eskom, Denel and South African Airways) all of which revolve around the resistance of the Treasury to finance their respective bailouts. The biggest specialist investor in fixed interest in South Africa, Futuregrowth, has taken the decision to suspend financing any new loans to some SOEs, setting conditions for resumption. A Danish Bank (Jyske Bank) has withdrawn financial support from Eskom. Moreover, the International Monetary Fund (IMF) reduced its projections of growth in South Africa between April and July 2016, now expecting growth of 0.1 percent in 2016 and 1.0 percent in 2017. These recent developments will have an impact on the rating agencies in their next review. In this series of three briefs, one on each rating agency, an account will be given of how agencies evaluated the South African economy in their most recent reviews. Given the deterioration in outlook, there is serious cause for concern about their next reviews.
The most recent decision
A negative outlook was assigned by Moody’s to South Africa’s long-term government bond (Baa2) and issuer ratings, following a review for downgrade in March 2016. The rating agency believes that:
- South Africa is possibly approaching a turning point after several years of shrinking growth;
- The 2016/17 budget and medium term fiscal plan will stabilise and in due course reduce the general government debt; and
- Recent political events (although disruptive) testify to the strength of South Africa’s institutions.
A Baa2 rating was confirmed for the ZAR Sovereign Capital Fund Propriety Limited whose debt issuance is ultimately the obligation of the South African government. The negative outlook remained. No change was made to South Africa’s local or foreign currency country ceilings and they remain at A1 for local currency debt and deposits.
The reasons for confirming the rating
The three key drivers for confirming existing ratings are:
The likelihood of growth recovery beyond 2016
Moody’s expect the economic growth of South Africa to become progressively stronger after the trough this year, as the supply-side shocks that slowed down economic activities are now more or less settled. For instance, the electricity supply is now more reliable, the drought is abating and various strikes that have caused work days lost have decreased significantly.
On the other hand, the inflation rate is more subdued than before when the South African Reserve Bank (SARB) projected inflation at eight percent by the end of the year. This means less contraction in monetary policy, reducing pressure on highly indebted households and supporting growth.
A more competitive exchange rate is also likely to strengthen growth in South Africa in the second half of the year and afterwards. Moody’s expect growth to be 0.5 percent in 2016 and 1.5 percent in 2017.
Structural reforms and reduced infrastructure bottlenecks give potential for growth over the medium term. Recent collaboration between government, business and labour shows the way for identifying and acting on areas of mutual concern, for instance, the rationalisation of state-owned enterprises and the enactment of labour market reforms. The implementation of such measures would help boost business confidence, investment and thus job creation. They would gradually reduce huge economic disparities, deprivation, high level of poverty and unemployment.
The likelihood that general government debt ratio will stabilise in 2016/17
The adoption of more aggressive consolidation measures in the recent budget increases the likelihood that general government debt to GDP ratio will be stable this year at 51 percent. The government has taken the decision to implement fiscal consolidation to return public finances to sustainability, while at the same time protecting main social and economic programmes. This was done through tax policy adjustment to raise tax revenue, moderation of expenditure and reprioritisation of state budgets.
Moody’s refers to the government’s recent track record of achieving fiscal targets, especially by maintaining an expenditure ceiling and recapitalising state-owned companies. The budget shows a high degree of flexibility. For instance, small unallocated spending has been re-established in the new budget framework and existing allocations have been shifted to other emerging needs such as drought relief and higher education spending. Such flexibility will help the government to address unanticipated issues without affecting the spending ceilings. The National Treasury also stated that expensive new projects such as the construction of massive nuclear power facilities and the National Health Insurance (NHI) will be developed only if state funds are available.
Recent Political developments testify South Africa’s institutional strength
Moody’s assesses the strength of South Africa’s institutions as high. Monetary and fiscal institutions remain sound over time. Despite disruptive political developments, the government continues to show the determination to bring public finance under control.
The negative outlook is based on the downside risks related to growth, the fiscal and political outlooks, and the likelihood that volatility in global financial markets could result in external imbalances. It is also based on the challenges government faces in enhancing medium-term growth and stopping the deterioration in the government’s balance sheet.
Moody’s would likely downgrade South Africa’s rating if the following were to happen:
- Economic growth fails to revive;
- Government’s efforts to stabilise and improve its debts metrics are unsteady;
- Investor confidence declines to the extent that external financing is not enough to fund the current account deficit on an extended basis;
- Lack of implementation of policies and measures that would secure a better investor climate and attract private investment; and
- Delayed reforms that would address fundamental economic rigidities and enhance competitiveness.
Moody’s could change the outlook from negative to stable if:
- Government delivers on commitments that support growth;
- Government achieves stabilisation as promised and reduces general government debts; and
- Measures to restore business confidence are taken.
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