SA avoids credit downgrade to junk as Fitch, Moody’s grant respite

National Treasury celebrated yesterday’s news from ratings agency Fitch as evidence that South Africa’s credit rating can avoid being downgraded to “junk” status and enjoyed welcome support from Moody’s this morning. But with the Fitch lowering in the outlook from neutral to negative, the rating is now right on the edge. A similar adjustment from S&P would drop its rating below the current Investment Grade level, becoming the first of the three major ratings agencies to do so. Whatever S&P decides, the country has avoided a downgrade to junk – at least for now. Moody’s kept its rating unchanged two notches into investment grade. Traditionally, investors judge the overall rating on two of the three major agencies. But with the slide continuing and little prospect of the desperately needed structural reforms, the downgrade still remains inevitable. But not just yet. Further down the page you can read the full response from Treasury to the Moody’s and Fitch announcements. – Alec Hogg

By Arabile Gumede and Thembisile Dzonzi

(Bloomberg) — South Africa moved closer to a junk credit rating after Fitch Ratings Ltd. changed the outlook on its assessment to negative from stable and warned continued political instability could result in a downgrade.

The foreign-currency rating and the local-currency rating were kept at BBB-, the lowest investment-grade level and on par with Hungary and Russia. S&P Global Ratings, which shares Fitch’s assessment, will publish its report on Dec. 2.

Image courtesy of Twitter
Image courtesy of Twitter

Political risks to the standards of governance and policy making have increased and will remain high at least until the ruling African National Congress’ leadership election in December next year, Fitch said in an e-mailed statement. Continued political instability that adversely affects standards of governance, the economy or public finances could lead to a downgrade, the company said.

‘Pretty Troubling’

“It does strengthen the narrative that things are pretty troubling right now and that the country really needs to turn things around,” said John Ashbourne, the Africa economist at Capital Economics Ltd. in London. “Moody’s is the most likely to change because it’s a bit of an outlier but I think these agencies all look at the same thing so they all probably look at things similarly.”

The rand weakened as much as 0.5 percent before reversing the decline to trade 0.3 percent stronger at 14.11 per dollar. A weakening currency and low economic growth are among the factors driving an increase in South Africa’s level of debt as a percentage of gross domestic product, Moody’s Investors Service said Friday, without making any announcement on the country’s rating or outlook. The nation’s debt to GDP ratio stands at 44 percent, data compiled by Bloomberg show.

Political turmoil in Africa’s most-industrialized economy, including now-dropped fraud charges against Finance Minister Pravin Gordhan, has overshadowed the state’s efforts to boost investor and business confidence, including recent proposals to stabilize the labor market. The slowest output growth this year since a 2009 recession will complicate Gordhan’s pledge to narrow the budget deficit to 2.5 percent of gross domestic product by 2020, from a projected 3.4 percent this year, and to limit government debt.

Gordhan, 67, who has led efforts to stave off a downgrade while wrangling with President Jacob Zuma over the management of state-owned companies and the national tax agency, said Friday he was “optimistic” about Moody’s review after Fitch left its rating unchanged.

Pravin Gordhan, South Africa's finance minister, speaks during an interview in London, U.K., on Thursday, Mar. 4, 2010. Gordhan said he is “disappointed” by the response of developed countries to the government’s plan to seek about $4 billion in loans from the World Bank. Photographer: Chris Ratcliffe/Bloomberg*** Local Caption *** Pravin Gordhan

Gordhan was reappointed at the end of last year to the position he held from 2009 until 2014 after Zuma was forced to change his decision to replace former Finance Minister Nhlanhla Nene with a then little-known lawmaker, which sent the rand and bonds plunging.

‘Mixed Messages’

“The in-fighting within the ANC and the government is likely to continue over the next year,” Fitch said. “This will distract policy makers and lead to mixed messages that will continue to undermine the investment climate, thereby constraining GDP growth.”

Fitch forecast the economy will expand by 0.5 percent this year, 1.3 percent in 2017 and 2.1 percent in 2018. If GDP growth fails to recover due to economic policy uncertainty or if the government fails to stabilize its debt ratio it could also lead to a downgrade, Fitch said. The nation’s debt to GDP ratio is accumulating “steadily,” Moody’s, which rates the country’s debt two steps above junk with a negative outlook, said in a statement Friday. The ratings company cited a delay in growth and a faster-than-projected rise in interest rates as key risks to a stabilization of the debt-to-GDP ratio by 2018-2019.

‘Buys Time’

“The fact that we have been able to preserve our investment-grade rating even in the face of all the global and domestic challenges is good enough for now,” Treasury Director-General Lungisa Fuzile said by phone. “This buys us more time. I really believe we are on the brink of turning things around.”

While the country had dodged a bullet, the negative outlook meant the rating move would be into junk territory, said Christie Viljoen, an economist at KPMG LLP in Cape Town. That would probably increase borrowing costs, making it more difficult for the government to meet its fiscal targets and rein in debt.

“They are sending the same signal as what we have had from S&P since late last year, that the next move is down to a place where you don’t to be,” Viljoen said “We need an effort right form the top of government to get this economy going.”

National Treasury on Moody’s:

Moody’s Investors Service (Moody’s) left  South Africa’s government bond long and short term ratings of ‘Baa2 / P-2’  unchanged with a negative outlook, two notches above sub-investment grade. This is after the agency decided not to have a formal review process given their recent affirmation of the sovereign rating in May 2016.

Government notes the decision taken by Moody’s and would like to thank, not only those who took part in the review process, but also to all South Africans who continue to support a common goal of promoting social transformation and more inclusive economic growth.

The South African economy is showing resilience, supported by strong and independent institutions. Other credit rating strengths are:

  • The Constitution and the Public Finance Management Act (1999) entrench a centralised, accountable framework for fiscal management;.
  • South Africa’s inflation targeting policy, implemented by the South African Reserve Bank since February 2000, has helped to anchor inflation expectations and reduce interest rate volatility;.
  • The floating exchange rate regime continues to provide the economy with buffers against external shocks, while at the same time limiting the risk of excessive domestic exposure to foreign currency liabilities;
  • Government has low foreign currency-denominated debt with long maturities (accounting for around 10 per cent of total government debt and only 4 per cent of GDP) which is much lower than most of its peers. The domestic bond market is deep and liquid, reducing debt-refinancing risks. Loans and guarantees by subnational government are limited and subject to national legislation. Provinces are almost entirely funded through transfers from national government. Borrowing by local governments is capped and limited to major metros with significant revenue-raising powers;
  • The fiscal framework is underpinned by credible macro-fiscal forecasts. The South African Revenue Service (SARS) has consistently improved the efficiency of the tax system and has generally exceeded revenue collection targets. And despite new spending pressures, government has maintained the expenditure ceiling;
  • The National Treasury’s long-term model suggests that existing core social spending priorities (e.g. education, health and social grants) are sustainable over the coming decades. In addition, the Government Employee Pension Fund is well funded;
  • South Africa exports are increasing, particularly to Asia and Europe. Increasing foreign investments by SA companies are resulting in higher dividends from their offshore investments. Therefore, the deficit on the current account of the balance of payments improved from 5.3 per cent of GDP in the first quarter of 2016 to 3.1 per cent of GDP in the second quarter of 2016;
  • The banking system is strong and well regulated with capital adequacy ratios well above the minimum regulatory capital requirement of 15 per cent;
  • South Africa improved seven places to reach 49th in the Global Competitiveness Report for 2015/16, reversing a four-year downward trend.

Furthermore, government has a very good track record on fiscal policy. Over the medium term, the fiscal strategy proposes the following to ensure sustainable public finances:

  • Spending ceiling – The MTBPS proposes R26 billion in reductions to the expenditure ceiling over the next two years, while protecting social spending.
  • Tax revenue measures – Proposed tax measures amount to R43 billion over the next two years (proposed in the 2016 Budget and the MTBPS).
  • Spending to boost economic growth – Government has budgeted R987.4 billion for infrastructure over the medium-term expenditure framework (MTEF) period, with large investments continuing in energy, transport and telecommunications.
  • Spending pressures will be accommodated through the contingency reserve Improving the quality of spending – In an environment of slow economic growth and limited resources, government is committed to reducing waste so that spending produces the intended results, through procurement reforms. Over the next three years, the legal and regulatory framework will be strengthened to improve the relationship between expenditure and outcomes.
  • Monitoring and controlling costs – The cost-containment measures introduced in December 2013 were issued to guide spending on consultants, travel, catering, entertainment and venue hire. These measures, linked with procurement reforms and budget reductions introduced during the same period, have succeeded in curtailing spending on non-essential goods and services. In real terms, spending on these items has fallen by 7.7 per cent. This includes a 12.6 per cent real decline in spending on consultants since 2012/13.

During and since the tabling of the Medium Term Budget Policy Statement the following has taken place:

  • Government continues to fast-track the implementation of micro reforms in sectors with potential to boost short-term growth including tourism, agriculture and oceans economy.
  • Government has ensured sustainable public finances while promoting economic growth by setting limits to government debt and expenditure, while supporting stronger public and private sector investment.
  • Government has not only adhered to the expenditure ceiling set during the 2016 Budget, but has reduced it further and proposed additional tax measures aimed at ensuring that government debt stabilises in the medium term. Further, government is committed to reducing waste so that spending produces the intended results, through procurement reforms. Over the next three years, the legal and regulatory framework will be strengthened to improve the relationship between expenditure and outcomes which is essential in an environment of slow growth and limited resources.
  • Cabinet has endorsed the private sector participation framework for state-owned companies and the guidelines for the remuneration and incentive standards for directors of these companies.
  • Cabinet approved the revised Integrated Energy Plan and was published for public discussion to afford stakeholders and interested parties to engage with it.
  • The Advisory panel on the minimum wage led by the Deputy President published a report proposing a national minimum wage of R3 500 per month. The report represents a balanced, thoughtful and constructive approach to addressing the challenge of inequality and unemployment.

While a lot has been achieved, government together with business, labour, civil society and the South African public will continue to fast-track reforms aimed at making South Africa an increasingly attractive investment destination.

Date: 25 November 2016

National Treasury on Fitch:

Fitch has affirmed its ‘BBB-’ ratings on South African government’s long term debt held in foreign and local currencies. The short term debt held in foreign and local currencies was also been affirmed at ‘F3’. The rating outlook has been revised to negative from stable.

Credit rating downgrade

Efforts made by South Africa to keep the country on an investment grade have paid off. Government, business, civil society, labour and politicians continue to work hard to build a foundation for faster growth. During and since the tabling of the Medium Term Budget Policy Statement the following has taken place:

  • Government continues to fast-track the implementation of micro reforms in sectors with potential to boost short-term growth including tourism, agriculture and oceans economy.
  • Government has ensured sustainable public finances while promoting economic growth by setting limits to government debt and expenditure, while supporting stronger public and private sector investment.
  • Government has not only adhered to the expenditure ceiling set during the 2016 Budget, but has reduced it further and proposed additional tax measures aimed at ensuring that government debt stabilises in the medium term. Further, government is committed to reducing waste so that spending produces the intended results, through procurement reforms. Over the next three years, the legal and regulatory framework will be strengthened to improve the relationship between expenditure and outcomes which is essential in an environment of slow growth and limited resources.
  • Cabinet has endorsed the private sector participation framework for state-owned companies and the guidelines for the remuneration and incentive standards for directors of these companies.
  • Cabinet approved the revised Integrated Energy Plan and was published for public discussion to afford stakeholders and interested parties to engage with it.
  • The Advisory panel on the minimum wage led by the Deputy President published a report proposing a national minimum wage of R3 500 per month. The report represents a balanced, thoughtful and constructive approach to addressing the challenge of inequality and unemployment.

All these developments have ensured an investment grade status for South Africa. If we continue at this pace and with such strong collaborations (government, business, labour, civil society and the general public) with a common goal, we will revise course and place South Africa on a sustainable path of faster and inclusive growth.

There are however risks to South Africa’s investment grade status as highlighted by Fitch:

National_Treasury_Logo_Mar_2016

  • Fitch believes that political risks to standards of governance and policy making have increased and expects them to remain high at least until the electoral conference of the African National Congress (ANC) in December 2017, undermining the investment climate, thereby constraining GDP growth.
  • Fitch mentioned that additional spending on student bursaries as a result of student protests was absorbed by using the contingency reserve, some one-off financing and a re-prioritisation of other expenditures, but the protests showed that social pressures could lead to further spending needs.
  • According to Fitch, political noise may undermine government efforts to improve the governance of state-owned companies, which could affect the plan to stream-line their portfolio.

However, government notes the announcement and the risks highlighted by Fitch. Preserving an investment grade rating may contain the increase in borrowing costs and input costs for government, corporates and individuals. This outcome ensures that:

  • Government continues to spend more of its resources on social programs rather than debt costs
  • Ordinary South Africans retain the purchasing power of their income and the value of their assets
  • There is investor and consumer confidence

The fact that the country’s investment grade status has been maintained demonstrates the resilience of the country and its people, especially during difficult times, to achieve a common mission. In this regard, government sincerely thanks all South Africans for their efforts in ensuring that the country does not lose its investment grade status and we urge all South Africans to continue this close working relationship with government over the period ahead.