Zuma’s wrecking ball: More blows for SA as Moody’s downgrades credit rating

JOHANNESBURG — Moody’s has historically been more bullish on South Africa than S&P and Fitch, but all of that has started to change. Moody’s on Friday downgraded its credit rating for South Africa to Baa3 while also being assigned a negative outlook. The country is still one notch above junk but unless something changes soon, Moody’s looks set to junk South Africa as well – making it a wall-to-wall junk rating among the major rating agencies. President Jacob Zuma’s reckless decisions have spurred on the downgrade. If the ANC doesn’t wake and smell the coffee soon, its future and that of South Africans will be at risk of a total meltdown. It may be too late once the party realises that President Jacob Zuma is its and South Africa’s biggest liability. – Gareth van Zyl

By Kevin Lings*

On 9 June 2017, Moody’s Investors Service decided to downgrade South Africa’s sovereign credit rating one notch from Baa2 to Baa3. Furthermore, the rating was assigned a negative outlook. SA’s rating is now on the lowest level of investment grade, and clearly at risk of slipping into “junk status”. The long-term domestic credit rating was also downgraded one notch to Baa3, and assigned a negative outlook.

Read more: Zuma’s wrecking ball: S&P cuts SA to junk after Gordhan purged

The decision by Moody’s to downgrade South Africa’s sovereign credit rating one notch was largely expected by market participants. Moody’s has had South Africa on a negative credit outlook since 15 December 2015, and put the country on credit watch on 3 April 2017. Overall, the statement issued by Moody’s raised a number of important concerns, most especially the negative impact of recent political events on confidence, economic growth and government finances.

According to Moody’s, the key drivers for the latest downgrade are:

1)      The weakening of South Africa’s institutional framework. For example, the abrupt March 2017 Cabinet reshuffle illustrate an erosion of institutional strength.

2)      Reduced growth prospects reflecting policy uncertainty and slower progress with structural reforms. In particular, uncertainty over policy priorities has damaged investor confidence.

3)      The continued erosion of fiscal strength due to rising public debt and contingent liabilities. In particular, lower than expected growth will further delay the stabilisation of South Africa’s debt-to-GDP ratio, while pressures to raise public wages will again rise in the next fiscal year as the end of the current three-year agreement will open room for new negotiations. Underperformance on tax revenue collection is another risk.

The decision to keep South Africa’s credit rating on a negative outlook reflects the continued downside risks for growth and fiscal consolidation associated with the political outlook.

Read more: Now Fitch downgrades SA to junk – Zuma’s wrecking ball in full swing

According to Moody’s, South Africa maintains a number of credit rating strengths, namely:

1)      Deep domestic financial markets

2)      A well-capitalised banking sector

3)      A well-developed macroeconomic framework

4)      Low foreign currency debt.

5)      Adherence to the Constitution, and the rule of law continue to be the key pillars of strength. South Africa’s institutions, on balance, are still stronger than those of emerging market peers.

The outlook for SA’s credit rating from Moody’s will depend on the government’s success in safeguarding South Africa’s institutional, economic and fiscal strength. In particular, further delays in implementing growth enhancing reforms could result in SA being downgraded, or if liquidity pressures begin to reemerge at state-owned enterprises that require pronounced government intervention. Conversely, a decline in the value of government guarantees to state-owned enterprises would be credit positive.

President Jacob Zuma. (Photo: Bloomberg)

Moody’s remains the only major credit rating agency to assign South Africa an investment grade rating for both its long-tern foreign debt as well as its long-term domestic debt.

Overall, the tone of Moody’s credit assessment of South Africa’s has, understandably, changed significantly over the past year. The rating agency is clearly concerned that recent political developments will lead to a continued lack of investment confidence in the country, which will result in sustained low growth, leading to a further deterioration of government’s fiscal position. In other words, unless government is able to meaningfully encourage private sector investment, which leads to higher economic growth and an improvement in government finances, Moody’s will be forced to downgrade South Africa to below investment grade. Such a move would have very significant implications for South Africa’s ability to attract sufficient foreign investment – cost effectively – and on a sustained basis. Without sustained foreign investment that is cots effective the country will perpetually struggle to achieve the growth rates needed to meaningfully reduce the level of unemployment and address the rising levels of social discord.

  • Kevin Lings is chief economist at Stanlib

Full statement from Moody’s vice president Zuzana Brixiova:

Moody’s Investors Service today downgraded the long-term issuer and senior unsecured ratings of the Government of South Africa to Baa3 from Baa2 as well as the senior unsecured Shelf and MTN program ratings to (P)Baa3 from (P)Baa2, and assigned a negative outlook. The government’s senior unsecured short-term program rating was also downgraded to (P)P-3 from (P)P-2. The rating actions conclude the review for downgrade that commenced on 3 April 2017.

The key drivers for the downgrade are:

1) the weakening of South Africa’s institutional framework;

2) reduced growth prospects reflecting policy uncertainty and slower progress with structural reforms; and

3) the continued erosion of fiscal strength due to rising public debt and contingent liabilities

The Baa3 rating recognizes a number of important strengths that continue to support South Africa’s creditworthiness. However, the negative outlook reflects the continued downside risks for growth and fiscal consolidation associated with the political outlook. Over the medium-term, economic and fiscal strength will remain sensitive to investor confidence and hence uncertainty surrounding political developments, including prospects for structural reforms intended to raise potential growth and flexibility in fiscal expenditures.

In a related decision, Moody’s also downgraded to Baa3 from Baa2 the backed senior unsecured debt issued by ZAR Sovereign Capital Fund Propriety Limited, a special purpose vehicle whose debt issuance is ultimately the obligation of the South African government, and assigned a negative outlook.

South Africa’s long-term local-currency bond and deposit ceilings were lowered to A2 from A1, and the long-term and short-term foreign-currency bond ceilings lowered to A3/P-2 from A2/P-1, respectively. The long-term foreign-currency bank deposits ceilings was lowered to Baa3 from Baa2, while the short-term foreign-currency bank deposits ceiling was lowered to P-3 from P-2.

Ratings Rationale

Rationale for downgrading to Baa3

The downgrade reflects Moody’s view that recent political developments suggest a weakening of the country’s institutional strength which casts doubt over the strength and sustainability of the recovery in growth and the stabilisation of the debt-to-GDP ratio over the near-term.

First driver – evidence of systemic weakening of the institutional framework

The first driver for the downgrade is Moody’s view that South Africa’s institutional strength, the second factor in our rating methodology, has eroded.

The independence and strength of key institutions such as the judiciary, the Reserve Bank and the National Treasury are a key support in Moody’s assessment of South Africa’s credit profile, through ensuring the continuity of a predictable, credit-supportive policy environment. Moody’s has taken comfort from the manifest commitment of the country’s policy institutions to achieving a broad program of structural reforms through cooperation between government, labour, and business, while at the same time maintaining rigorous adherence to fiscal spending ceilings and embarking on reforms of state-owned enterprises.

South African president’s radical economic transformation. More magic available at www.zapiro.com

However, recent events, particularly but not exclusively the abrupt March Cabinet reshuffle, illustrate a gradual erosion of institutional strength. The institutional framework has become less transparent, effective and predictable, and policymakers’ commitment to previously-articulated reform objectives is less certain.

Second driver – reduced growth prospects

As a consequence, Moody’s views the underlying political dynamics which led to the March cabinet reshuffle as posing a threat to near- and medium-term real GDP growth.

Uncertainty over near- and medium-term policy priorities has damaged investor confidence, reducing investment in South Africa’s economy which fell by 3.9% in 2016 and is projected to remain subdued in 2017. Investment levels are likely to remain weak until a more stable policy environment emerges.

Medium-term growth will additionally be constrained by mixed progress with structural reforms, including delays in the implementation of reforms in the mining sector, in the governance of state-owned enterprises, and in the elimination of barriers to competition in key network sectors. With the economy already recording two consecutive quarters of contraction prior to the cabinet reshuffle, Moody’s forecasts growth below 1% in 2017 and 1.5% in 2018, with stagnating investment reducing medium-term (and potential) growth as well.

Third driver – continued erosion of fiscal strength

Lower levels of growth and heightened uncertainty about policy direction and policymakers’ commitment to structural reforms have increased the risk of a weakening of the government balance sheet.

In Moody’s view, lower than expected growth will further delay the stabilisation of South Africa’s debt-to-GDP ratio. Instead of stabilising in 2018/19 Moody’s now expects the debt burden will reach about 55% of GDP that year and continue to rise gradually afterwards. While the National Treasury has reiterated its commitment to expenditure ceilings, pressures to raise public wages will again rise in the next fiscal year as the end of the current three-year agreement will open room for new negotiations. Underperformance on revenue collection is another risk.

Furthermore, contingent liabilities linked to state-owned enterprises continue to pose a tail risk to the country’s fiscal strength. Operational inefficiencies, weak corporate governance, and poor procurement practices persist in SOEs, with government guarantees extended to SOEs rising. This has also increased the likelihood of contingent liabilities crystalizing on the government’s balance sheet. Pressures to further extend guarantees and utilise procurement practices to advance political objectives are sources of additional potential risk.

Rationale for the Baa3 rating

South Africa maintains a number of credit strengths that support its Baa3 rating. These include deep domestic financial markets and a well-capitalized banking sector; a well-developed macroeconomic framework; and low foreign currency debt. Moreover, deterioration in the factors driving the downgrade has been gradual. Importantly, adherence to the Constitutionƒ accountability and the rule of law continue to be the key pillars of strength of South Africa’s institutions, with South Africa’s institutions on balance still stronger than those of emerging market peers.

Rationale for assigning a negative outlook

The negative outlook reflects Moody’s view that the risks to growth and fiscal strength arising from the political outlook are tilted to the downside. It is unlikely that a political consensus will emerge which supports investment in the economy and reinvigorates the reform effort sufficiently quickly to reverse the expected negative impact on growth and on the government’s balance sheet. The opposite scenario, of heightened political dysfunction, continued gradual institutional weakening and diminished clarity over policy objectives, has a higher likelihood.

What could change the rating — down

The future trajectory of the rating will depend on the government’s success in safeguarding South Africa’s institutional, economic and fiscal strength. Indications that the strength and independence of the country’s institutions have diminished to a greater extent than in Moody’s baseline scenario, or that the emerging policy framework has become even less predictable or has shifted in a way likely to undermine economic or fiscal strength, could lead to a further downgrade. Further delays in growth enhancing reforms would be suggestive of such a shift. Downward pressure could also develop if liquidity pressures begin to reemerge at state-owned enterprises that would elicit pronounced government intervention, be it through the activation of guarantees or other measures.

More of Zapiro’s magic available at his website www.zapiro.com.

What could lead to stabilisation of the outlook at the current rating level

Conversely, Moody’s could change the rating outlook from negative to stable if the government were to deliver on commitments that indicated the continued independence and strong policy-making capabilities of South Africa’s policy institutions, and which enhanced medium-term growth and achieved the planned stabilization in the government’s debt burden. A decline in the value of guarantees to state-owned enterprises would also be credit positive.

Prompted by the factors described above, the publication of this credit rating action occurs on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.

GDP per capita (PPP basis, US$): 12,679 (2016 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 0.3% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 6.8% (2016 Actual)

Gen. Gov. Financial Balance/GDP: -3.7% (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -3.2% (2016 Actual) (also known as External Balance)

External debt/GDP: 52.3% (2016 Actual)

Level of economic development: Moderate level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

  • Zuzana Brixiova is Moody’s vice president: Senior Analyst and lead sovereign analyst for South Africa

Statement from National Treasury:

Moody’s Investors Service (Moody’s) downgrades South Africa’s ratings to ‘Baa3’ – still an investment grade rating – and maintains a negative outlook

Government notes the decision by Moody’s to downgrade South Africa’s long-
term foreign and local currency debt ratings to ‘Baa3’ from of ‘Baa2’ and maintain the negative outlook, an investment grade rating. This rating action concludes Moody’s decision to place the sovereign under review for a possible downgrade.

Finance Minister Malusi Gigaba

According to Moody’s, the downgrade was driven by:

  • The weakening of South Africa’s institutional strength;
  • Reduced growth prospects reflecting policy uncertainty and slower progress with structural reforms; and
  • The continued erosion of fiscal strength due to rising public debt and contingent liabilities

The negative outlook reflects continued downside risks for growth and fiscal consolidation associated with the political outlook. Over the medium-term, economic and fiscal strength will remain sensitive to investor confidence and
hence uncertainty surrounding political developments, including prospects for structural reforms intended to raise potential growth and flexibility in fiscal expenditures, according to Moody’s.

While the ratings are still investment grade, the negative outlook indicates that the risk of further downgrades is still there. On that note, government calls on all South Africans, including the private sector and trade unions to work even harder together to address these concerns. The foundation for a higher growth path and socio-economic development has already been made:

  • The National Development Plan (NDP) continues to anchor all policies of government.
  • The 9 Point Plan has been approved as a catalyst for growth in the immediate horizon, and is being implemented.
  • Reforms to address the structural challenges that limit the economic growth potential are already being implemented and progress has been made, especially on labour reforms.
  • Reforms to address governance and financial weaknesses besetting state-owned companies (SOCs) are being implemented.

Cabinet has:

  • Endorsed a private-sector participation framework to guide collaboration between SOCs and the private sector on infrastructure projects;
  • Adopted a guideline for the remuneration and incentive standards for directors of SOCs;
  • Approved the broad thrust of a guide for the appointment of boards and executive officers;
  • Recommended further consultation on the first draft of a new government shareholder policy, which will culminate in overarching legislation for SOCs; and
  • Noted the proposal to determine and cost the developmental mandates of SOCs.

Other key policies that are being concluded that have the potential to raise investment include:

  • The Mining Charter;
  • The broadband spectrum;
  • The revised draft of the Integrated Energy Plan and the base case and assumptions of the Integrated Resource Plan;
  • Amendments on the Labour Relations Act;
  • Draft First Amendment of the Immigration Regulations; and
  • The Regulation of Land Holdings Bill and Communal Land Tenure Bill.

Policy transparency and continuity remain on top of government’s agenda and the ruling party in 2017. The outcomes of the conferences of the African National Congress in June and December 2017 are not expected to translate to policy deviations in the next five years.

The urgent priority is reigniting confidence as well as reclaiming and maintaining the investment grade ratings. The Minister of Finance will ensure that the joint work of government, business, labour and the civil society continues at a faster pace. The commitment is on improving investor and consumer confidence through fast-tracking the implementation of the structural reforms on economic growth.

Government would like to thank all stakeholders who participated in the rating review process and hope that such collaborations will continue.

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