S&P: South Africa not out of the woods yet. Fate lies in hands of policy makers.

JOHANNESBURG — All eyes will be on the budget tomorrow after a series of tumultuous weeks in South African politics. And, as S&P Global indicates, a lot more needs to be done before South Africa can even begin to restore its credibility with investors again. Rating agencies will be watching today closely. Massive pressure will be on Team Ramaphosa to get South Africa out of the financial mess it finds itself in. – Gareth van Zyl

By Bravura Holdings*

Konrad Reuss, S&P Global Ratings MD for sub-Saharan Africa and SA, gave a sobering view on S&P’s views on the South African economy at the GIBS Economic Outlook conference held earlier today.

He said that South Africa’s investments grade status recovery depends on reform of fiscal policy, public sector reform and the willingness of the South African population to take pain to achieve it. He also mentioned that South Africa has not recovered in a meaningful way since the global financial crisis in 2008.  In his view, South Africa lags behind both the world and emerging markets.

“SA’s first challenge is to improve economic growth, but perhaps our larger challenge, given high levels of income inequality, is to make sure growth is equitable and has wide distribution that will reduce inequality.  Improvements in income distribution are key measures of achieving inclusive growth, although we must go beyond traditional measures (GDP per Capita) to monitor progress.”

A view shows the Standard & Poor’s building in New York’s financial district. REUTERS/Brendan McDermid

Soria Hay, Head of Corporate Finance at Bravura comments: “Standard & Poor downgraded its credit rating for South Africa in November 2017 to BB (below investment grade). This decision by S&P led to South Africa being excluded from the Barclays Global Aggregate index, whose inclusion criteria requires investment grade rating on its local currency debt from any two ratings agencies. Fitch already downgraded South Africa’s credit rating to BB+ in April 2017, and this meant that South Africa was excluded from the Barclays index as well as the JPMorgan Emerging Market Bond Index Global.”

Moody’s adopted a “wait and see approach”, and retained South African debt ratings at investment grade, but put it on review for downgrade. Moody’s said at the time that the review period will allow the rating agency to assess the South African authorities’ willingness and ability to respond to the rising pressures through growth-supportive fiscal adjustments that raise revenues and contain expenditures; structural economic reforms that ease domestic bottlenecks to growth; and improvements to SOE governance that contain contingent liabilities.”

Flag map of South Africa

Hay says: “The future of South Africa’s credit ratings hangs in the balance as the world waits to see what the 2018 budget will deliver.  The finance minister is expected to announce plans to plug a R50-billion hole in revenues, and will also have to provide for other demands – such as free higher education for students from low-income households which is expected to cost up to R15-billion for this financial year.

The plan to address these issues, and many more that weigh on the budget, will provide clarity as to whether South Africa’s credit rating is doomed to be further downgraded into junk territory – or if a grace period will allow for the country to prove it can turn its fortunes around.”

After the medium-term budget policy statement budget, Moody’s expressed concern, noting that SA’s interest payments ratio exceeds the median of its peer ratings group.  According to Moody’s, more than a third of all sovereign defaults occur when countries allow fiscal imbalances to persist, resulting in unsustainably high debt burdens. When they are no longer able to service or reduce their debt, downgrades invariably follow.

S&P Global warned that non-resident ownership of South African local currency debt was now at 45%.  Hay explains why this poses a potential risk: “If both Moody’s and S&P downgraded South Africa’s local currency debt to junk, South African bonds would fall out of the Citigroup’s World Government Bond Index (WGBI), causing large international tracker funds to sell out of their holdings of such bonds.

credit rating downgrade crisis

Ejection from the crucial bond indexes means passive investors mandated to invest in local bonds would automatically have to withdraw from those investments. Downgrades to sub-investment grade could trigger forced selling of up to as $14bn of outflows, according to the Bank of America. If Moody’s, also downgrades South Africa, then far greater losses on the Rand can be expected. The Rand could depreciate rapidly, causing inflation to increase, putting upward pressure on interest rates and downward pressure on economic growth.”

S&P Global is concerned about the low growth environment in South Africa, and also the economic inequality that exists in the country.  Hay comments that the GDP per capital expressed in USD has declined by 30% since 2012.

South Africa – GDP per capita (USD) Data (Source: FocusEconomics S.P.)

2012   2013   2014   2015   2016  
GDP per capita (USD) 7,599 6,704 6,621 6,065 5,299

S&P Global commented: “We could raise the ratings if economic growth or fiscal outcomes strengthen in a significant and sustained manner compared with our base case. Upside ratings pressure could also rise if risks of a marked deterioration in external funding sources were to subside, in our view, and external imbalances decline. Upward pressure on the ratings could also develop were policy makers to introduce economic reforms to benefit job creation, competitiveness, and economic growth.”

Finance Minister Malusi Gigaba

S&P Global warned that the average time that it takes a country to move back to investment grade after it has been down-graded, is an average of 8.3 years; ranging from slightly more than a year for South Korea (between December 1997 and January 1999) to more than 19 years for the recent upgrade of Indonesia (between December 1997 and May 2017).

Interestingly, numbers are similar for movements in the opposite direction. It also took an average of 8.3 years for the nine sovereigns in the rising star category to lose their investment-grade ratings. It took South Africa more than 17 years for South Africa (between February 2000 and April 2017.)

Hay concludes: “We are at a crossroads. South Africa will only through a concerted effort by government and business reach its full potential. To a very large extent, the private sector holds the key, but government holds the door.”

  • Bravura Holdings Limited is an independent investment banking firm specialising in corporate finance and structured solutions services. Bravura Holdings has a primary listing on the Stock Exchange of Mauritius and a secondary listing on the NSX. It has offices in Mauritius, South Africa, Namibia and Australia.
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