Azar Jammine: Rating agencies giving Gigaba’s Treasury benefit of the doubt

Despite being downgraded to junk status by Fitch Ratings earlier this year, South Africa still hasn’t fully felt the backlash of being in the world’s relegated economic division. While the rand has been on somewhat of a yo-yo in recent months, it hasn’t weakened to the extent that it did during Nenegate. Of course, one could argue that the markets factored in the damage already, but, as Azar Jammine outlines below, if South Africa’s rand demominated bonds get junked (which they haven’t yet) it could cause some serious pain. That prospect, at this stage, seems a distant possibility. But a possibility nevertheless. Rating agencies are very much taking a wait-and-see approach. – Gareth van Zyl

Malusi Gigaba, South Africa’s finance minister, reacts during a news conference in Pretoria, South Africa, on Saturday, April 1, 2017. Photographer: Waldo Swiegers/Bloomberg

By Azar Jammine*

Key Points

  • Fitch credit rating agency, in releasing its normal biannual review in June, maintained its BB+ credit rating on both South Africa’s foreign currency and local currency debt.
  • The outcome is no surprise as the agency pre-empted having to downgrade ratings at this time of the year by doing so immediately after the Cabinet reshuffle. There has been no further major deterioration in the economic outlook and fiscal picture to warrant an immediate further ratings downgrade.
  • Instead, the unchanged stance effectively reflects a wait-and-see attitude to determine the extent to which government sticks to its plans of fiscal consolidation and does not embark upon populist measures. The agency is clearly also anxious to determine the extent to which economic growth might improve in such a way as to avoid jeopardising revenue collections unduly.
  • The good news from this latest action is that it confirms our previous stance suggesting that the worst-case scenario of South African government bonds falling out of world government bond indices, with dramatically negative implications for the Rand, inflation, interest rates and economic growth, is unlikely to manifest itself at least over the remainder of this year. The Fitch move suggests that S&P is likely to refrain from downgrading its local currency debt to junk status and that if Moody’s does downgrade its credit rating, it will do so by just one notch, thereby also retaining its local currency credit rating at investment grade.

As expected, Fitch believes its credit rating unchanged at best junk level

Azar Jammine
Dr Azar Jammine is a leading South African economist.

Fitch credit ratings agency released its traditional biannual credit rating review of South Africa, as is normally the case, in June. It reflected an unchanged credit rating for both foreign and local currency debt, at BB+, the highest sub-investment grade or junk rating. The outlook was also retained at “stable”, implying the absence of a high likelihood of changing the credit rating at the next review. This decision came as no surprise. It follows the decision in early April by S&P Global Ratings and Fitch to downgrade South Africa’s foreign currency credit rating to junk status a matter of days after the Cabinet reshuffle. The downgrade decision by these ratings agencies so soon after the Cabinet reshuffle, took the markets somewhat by surprise because they had expected that if such downgrades were to take place, they would happen in June when the traditional biannual credit rating reviews of these agencies were published. Instead, the decision to downgrade so soon after the Cabinet reshuffle represented a proactive step two months in advance of the normal reviews. The fact that pre-emptive action of this kind was taken in turn meant that it was that much less likely that the traditional reviews would incorporate further downgrades so soon after the April ones. Only in the event of a major further deterioration in the country’s fiscal framework or macroeconomic environment could one have expected a further downgrade just two months after the last one. In the event, little has transpired since the initial damage caused by the Cabinet reshuffle to make one believe that the economic environment has taken a marked further step of deterioration. On the contrary, some of the developments since those ratings downgrades might be deemed to be positive for the economic outlook rather than negative.

Soon after those credit ratings downgrades many analysts, including ourselves, revised our forecasts for economic growth in 2017 and 2018 downwards. There were also associated downward revisions of forecasts for the Rand and together with this, forecasts for some deterioration in the inflation outlook. As things stand however, the Rand is actually no worse than where it was prior to the April ratings downgrades. Similarly, long-term interest rates are barely different from where they were then. If anything, therefore, economic growth forecasts might need to be revised back upwards slightly compared with the downward revisions undertaken in April.

Unsurprising items highlighted as reasons for concern

Furthermore, the items highlighted by Fitch as needing to be addressed to avoid further credit ratings downgrades, are very much in line with what one might have expected. Firstly, the agency is watching closely the trends of South Africa’s government debt to see whether there is any marked abandonment of fiscal discipline in the face of rhetoric expressing the need for “radical economic transformation“. In this regard, as we suspected the ratings agencies would do, they seem to be giving the new leadership of National Treasury the benefit of the doubt. The Fitch statement expressly says “senior ANC and government leaders have emphasised that the government’s recent rhetoric of “radical economic transformation” signals no fundamental change and that the government remains focused on the long-standing goal of inclusive growth. Documents released ahead of the ANC policy conference in June also indicate policy continuity, including on the sensitive issue of land expropriation“.

In other words, Fitch suggests that it is unlikely that we will see a major deterioration in the country’s fiscal situation in the short term to warrant a further credit rating downgrade. However, also as expected, the agency has highlighted its concerns about the level of governance at state-owned enterprises (SOEs). It highlights Eskom and SAA in particular as potentially having to receive government loans which might exacerbate the public debt to GDP ratio. Fitch bemoans the deterioration in South Africa’s ranking in the World Bank’s governance indicator largely due to the heightened decline in governance at these enterprises. At the same time, the agency expresses its confidence that any further deterioration in governance of SOEs is unlikely to escalate dramatically from current levels. It is also optimistic about the current-account managing to improve on the back of better export prices for the country’s exports and reduced demand for imports associated with declining investment levels. Its biggest gripe, however, lies with the continuing low growth rate of the South African economy and its failure to generate the kind of revenue growth needed to facilitate a decline in the budget deficit and a capping the public debt. In this regard one can also be optimistic in that recent indicators suggest that the deterioration in the economy thus far caused by the Cabinet reshuffle, associated political turmoil and credit ratings downgrades already enacted, has been constrained. Combined with its continuing allocation of a “stable” outlook for South African debt, one can look forward with reasonable optimism to Fitch not undertaking further downgrades of the next six months at least, even if also at its next review in December.

Encouraging message for staving off “worst-case scenario”

With the exception of the JP Morgan Emerging Market Bond Index, the decision taken in April by Fitch to downgrade South Africa’s credit rating to junk status has not resulted in forced sales of bonds as a result of the bonds having to drop out of such indices. This represents one of the reasons why the Rand has held up so well since then. However, as we have frequently conveyed to clients, there is a possible downside scenario. If S&P and Moody’s follow Fitch’s example in downgrading South Africa’s credit rating on its local currency debt, which accounts for 88.5% of all its debt, to junk status, South African government bonds would need to fall out of major government bond indices, the most important of which is the World Government Bond Index (WGBI). Such a move could precipitate a steep sell-off in the Rand, causing inflation to rise, threatening to force interest rates upwards and the impact on economic growth would be disastrous. We know that both S&P and Moody’s are about to issue their reviews shortly. The decision now by Fitch to leave its rating unchanged from where it was reduced to in April, likewise suggests that these other agencies will also be conservative in terms of avoiding downgrades of the country’s local currency debt to junk status for the present at least. Even if Moody’s does reduce the country’s credit rating, the fact that its current rating is two notches above junk status implies that its local currency debt rating will remain at investment grade.

On the other  hand, in the same way as S&P jumped the gun so to speak in downgrading to junk status two months before its review in June, it is unlikely that it will take a further step right now to downgrade into junk. In other words, the worst-case scenario of South African bonds falling out of the WGBI is unlikely to materialise in the short term. At the very earliest it will occur when the agencies next review the ratings at the end of the year. Instead, as with Fitch, S&P and Moody’s are likewise likely to adopt a wait and see approach to determine whether the new leadership at National Treasury persists with fiscal rectitude and that the deterioration in governance of SOEs and government generally does not escalate. In this regard, one can draw encouragement from the latest e-mail Gupta-leaks. These have heightened the groundswell of opposition to state capture and deterioration in governance. They have entrenched the spirit of democracy and respect for institutions in the country and highlight the attributes of media freedom. These issues will no doubt also be taken into account positively by the ratings agencies. It is no coincidence that the manifestation of these leaks has been accompanied by a recovery in the Rand after it lost ground earlier this week on the back of the ANC’s NEC’s failure to recall president Zuma at the meeting last weekend.

  • Azar Jammine is the chief economist at Econometrix. 
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