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Just days after President Jacob Zuma fired his Minister of Finance Pravin Gordhan, credit ratings agency Standard & Poor’s has downgraded South Africa to junk status. In a statement outlined below, S&P lists its chief reasons for cutting the country to a BB+ rating – these range from its troubled state-owned enterprises such as Eskom to the country’s shrinking GDP per capita. But the ratings agency – which is the first so far to downgrade South Africa to junk – also puts Zuma’s “executive changes” at the top of its list of reasons for the downgrade, as it says the move to enforce a massive Cabinet reshuffle has put the country “at risk”. Gordhan and his deputy Mcebisi Jonas were seen as the last stand to the tentacle reach of the Zuptas, who are said to seek more time looting Treasury before Zuma faces an inevitable departure from his position as ANC president (and probably SA president). There’s no doubt that this downgrade is yet another key moment in South Africa’s history: either the country embarks on a Zimbabwe-type style of self-destruction or it uses this moment to clean up its house. Either way, on average it takes countries seven years to escape junk status – so the damage, in many respects, is already done. – Gareth van Zyl
Bloomberg – South Africa lost its investment-grade credit rating from S&P Global Ratings for the first time in 17 years in response to a cabinet purge by President Jacob Zuma that’s sparked increasing calls for him to resign. The rand weakened.
S&P knocked the foreign-currency rating to BB+, the highest junk score, on Monday and warned that a deterioration of the nation’s fiscal and macroeconomic performance could lead to further reductions. The local-currency rating was reduced to BBB-, still investment grade, from BBB. The outlook on the both ratings was kept at negative, signaling that the next move could be downward.
Zuma sacked Finance Minister Pravin Gordhan, who pushed for budget restraint, in a stunning cabinet reshuffle last week that’s ignited South Africa’s worst political crisis in almost a decade. Investors regard the firing as a blow to an economy growing at the slowest pace since the 2009 recession and grappling with 27 percent unemployment. The downgrade may further galvanize Zuma’s opponents within the ruling party to push for him to step down after unprecedented criticism from other African National Congress leaders.
“The downgrade reflects our view that the divisions in the ANC-led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk,” S&P said. “This has increased the likelihood that economic growth and fiscal outcomes could suffer.”
The rand slumped to the weakest level since January, declining 2 percent to 13.6734 per dollar by 6:05 p.m. in Johannesburg. Yields on the country’s dollar bonds due October 2028 jumped nine basis points to 5.11 percent, a three-month high, while rates on benchmark government rand bonds due December 2026 rose 13 basis points to 9.02 percent.
Investors already demand a bigger premium over Treasuries to hold South African dollar-denominated debt than Russia or Brazil, both junk credits.
The announcement was quick and “more potent, given the timing,” Razia Khan, head of macro research at Standard Chartered Plc in London, said by email. “It substantially raises the risk of ratings action from Moody’s which had assigned a higher rating to South Africa.”
Moody’s Investors Service, which rates the nation at two levels above junk with a negative outlook, is scheduled to publish its review on April 7.
Zuma doesn’t understand how his actions can influence decisions by rating companies, and his decisions showed a “recklessness” that ruined South Africa’s credibility, Motlanthe said in an interview at Bloomberg’s offices in Johannesburg.
Gordhan, who was replaced by former home affairs minister Malusi Gigaba, was removed after a months-long battle with Zuma over government spending. He’d been trying to ward off a downgrade with plans to narrow the budget shortfall to 2.6 percent of gross domestic product by the fiscal year ending in March 2020, from the current 3.4 percent.
“The rating action also reflects our view that contingent liabilities to the state, particularly in the energy sector, are on the rise,” S&P said. “Higher risks of budgetary slippage will also put upward pressure on South Africa’s cost of capital, further dampening already-modest growth.”
Pressure within the ANC has been growing on Zuma to step down after he recalled Gordhan from a trade trip in London March 27 where he was holding meetings with investors and ratings companies. Gigaba, who has no financial or business experience, is the nation’s fourth finance minister in 15 months.
“A downgrade wouldn’t be permanent,” Gigaba told reporters Monday in the capital, Pretoria, before the ratings announcement.
South Africa, the continent’s most-industrialised country, has enjoyed investment-grade standing at Moody’s since 1994, when the ANC came to power under Nelson Mandela. The other two ratings companies upgraded it above junk in 2000.
From Standard and Poors:
- In our opinion, the executive changes initiated by President Zuma have put at risk fiscal and growth outcomes.
- We assess that contingent liabilities to the state are rising.
- We are therefore lowering our long-term foreign currency sovereign credit rating on the Republic of South Africa to ‘BB+’ from ‘BBB-‘ and the long-term local currency rating to ‘BBB-‘ from ‘BBB’.
- The negative outlook reflects our view that political risks will remain elevated this year, and that policy shifts are likely, which could undermine fiscal and economic growth outcomes more than we currently project.
On April 3, 2017, S&P Global Ratings lowered the long-term foreign currency sovereign credit rating on the Republic of South Africa to ‘BB+’ from ‘BBB-‘ and the long-term local currency rating to ‘BBB-‘ from ‘BBB’.
We also lowered the short-term foreign currency rating to ‘B’ from ‘A-3’ and the short-term local currency rating to ‘A-3’ from ‘A-2’. The outlook on all the long-term ratings is negative.
In addition, we lowered the long-term South Africa national scale rating to ‘zaAA-‘ from ‘zaAAA’. We affirmed the short-term national scale rating at ‘zaA-1’.
As a “sovereign rating” (as defined in EU CRA Regulation 1060/2009 “EU CRA Regulation”), the ratings on the Republic of South Africa are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see “Calendar Of 2017 EMEA Sovereign, Regional, And Local Government Rating Publication Dates,” published Dec. 16, 2016, on RatingsDirect). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation.
In this case, the reasons for the deviation are the heightened political and institutional uncertainties that have arisen from the recent changes in executive leadership. The next scheduled rating publication on the sovereign rating on the Republic of South Africa will be on June 2, 2017.
The downgrade reflects our view that the divisions in the ANC-led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk. This has increased the likelihood that economic growth and fiscal outcomes could suffer. The rating action also reflects our view that contingent liabilities to the state, particularly in the energy sector, are on the rise, and that previous plans to improve the underlying financial position of Eskom may not be implemented in a comprehensive and timely manner. In our view, higher risks of budgetary slippage will also put upward pressure on South Africa’s cost of capital, further dampening already-modest growth.
Internal government and party divisions could, we believe, delay fiscal and structural reforms, and potentially erode the trust that had been established between business leaders and labour representatives (including in the critical mining sector). An additional risk is that businesses may now choose to withhold investment decisions that would otherwise have supported economic growth. We think that ongoing tensions and the potential for further event risk could weigh on investor confidence and exchange rates, and potentially drive increases in real interest rates.
We have also reassessed South Africa’s contingent liabilities. This reflects the increased risk that nonfinancial public enterprises will need further extraordinary government support. We expect guarantee utilisations will reach South African rand (ZAR) 500 billion in 2020, or 10% of 2017 GDP. The utilisations are dominated mainly by Eskom (BB-/Negative/–), which benefits from a government guarantee framework of ZAR350 billion (US$25 billion)–about 7% of 2017 GDP. We estimate Eskom will have used up to ZAR300 billion of this framework by 2020.
South Africa’s energy regulator has capped Eskom’s permitted 2017/2018 tariff increase at 2.2%–with negative implications for its financial performance. Eskom will fund the resulting revenue gap via borrowings of up to ZAR70 billion, of which up to half may utilise government guarantees. Other state-owned entities that we think still pose a risk to the country’s fiscal outlook include national road agency Sanral (not rated), which is reported to have revenue collection challenges with its Gauteng tolling system, and South African Airways (not rated), which may be unable to obtain financing without additional government support. While governance reforms have proceeded at the airline, Eskom still has to complete its board appointments and appoint a permanent CEO. Broader reforms to state-owned enterprises are still being discussed and we do not foresee implementation in the near term.
South Africa continues to depend on resident and nonresident purchases of rand-denominated local currency debt to finance its fiscal and external deficits. We estimate that the change in general government debt will average 4.2% of GDP over 2017-2020. On a stock basis, general government debt net of liquid assets increased to about 48% of GDP in 2017 from about 30% in 2010, and we expect it will stabilise at just below 50% of GDP in the next three years. Although less than one-tenth of the government’s debt stock is denominated in foreign currency, nonresidents hold about 35% of the government’s rand-denominated debt, which could make financing costs vulnerable to foreign investor sentiment, exchange rate fluctuations, and rises in developed market interest rates. We project interest expense will remain at about 11% of government revenues this year.
South Africa’s pace of economic growth remains a ratings weakness. It continues to be negative on a per capita GDP basis. While the government has identified important reforms and supply bottlenecks in South Africa’s highly concentrated economy, delivery has been piecemeal in our opinion. The country’s longstanding skills shortage and adverse terms of trade also explain poor growth outcomes, as does the corporate sector’s current preference to delay private investment, despite high margins and large cash positions.
South Africa’s gross external financing needs are large, averaging over 100% of current account receipts (CARs) plus usable reserves. However, they are declining because the current account deficit is narrowing. The trade deficit (surplus in 2016) has seen contraction, but given the small recovery in oil prices (oil constitutes about one-fifth of South Africa’s imports) we could see the trade balance weakening again. We could also see weaker domestic demand and a notable increase in exports from the mining and manufacturing sectors, along with a slower pace of increase in imports.
We believe sustained real exports growth is likely to be slow over 2017-2020 because of persistent supply-side constraints to production. Import growth will be compressed amid currency weakness and the subdued domestic economy. Therefore, we estimate current account deficits will average close to 4% of GDP over 2017-2020. However, South Africa funds part of its current account deficits with portfolio and other investment flows, which could be volatile. This volatility could stem from global changes in risk appetite; foreign investors reappraising prospective returns in the event of growth or policy slippage in South Africa; or rising interest rates in developed markets.
We consider South Africa’s monetary policy flexibility, and its track record in achieving price stability, to be important credit strengths. South Africa continues to pursue a floating exchange rate regime. The South African Reserve Bank (SARB; the central bank) does not have exchange rate targets and does not defend any particular exchange rate level. We assess the SARB as being operationally independent, with transparent and credible policies. The repurchase rate is the bank’s most important monetary policy instrument. Absent large currency depreciations, we expect that inflation will fall back below 6% this year and remain in the target range of 3%-6% over our three-year forecast horizon.
The negative outlook reflects our view that political risks will remain elevated this year, and that policy shifts are likely which could undermine fiscal and growth outcomes more than we currently project.
If fiscal and macroeconomic performance deteriorates substantially from our baseline forecasts, we could consider lowering the ratings.
We could revise the outlook to stable if we see political risks reduce and economic growth and/or fiscal outcomes strengthen compared to our baseline projections.
From National Treasury:
Government notes the sovereign rating announcement by S&P. While S&P has lowered its rating of foreign currency-denominated debt to a sub-investment grade, rand-denominated debt – which constitutes 90 per cent of the debt portfolio – retains its investment-grade rating.
While the leadership of the finance portfolio has changed, government’s overall policy orientation remains the same. As indicated by Minister Gigaba on 1 April 2017, “government has been, and will remain, committed to a measured fiscal consolidation that stabilises the rise in public debt”.
South Africa is committed to a predictable and consistent policy framework, which responds to changing circumstances in a measured and transparent fashion. Open debate in a democratic society should not be a cause for concern, but reflects an important means to accommodate differing views. South Africa’s constitutional arrangements remain robust. These key institutional strengths are acknowledged by rating agencies.
This rating announcement calls for South Africans to reflect on the need to sustain and act with urgency to accelerate inclusive growth and development so that we can reverse the triple challenge of poverty, unemployment and inequality. Reducing reliance on foreign savings to fund investment and relying less on debt to finance public expenditure will secure South Africa’s fiscal sovereignty and economic independence.
Government remains committed to making sure that its work with business, labour and the civil society continues in order to improve the business confidence and implement structural reforms to accelerate inclusive economic growth.
The Minister of Finance will engage further with the media tomorrow to discuss this outcome.
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