S&P less critical than expected but SA not out the woods yet. Next stop Fitch.

There was a huge sigh of relief on Friday evening as ratings agency Standard & Poors kept South Africa’s investment grade credit rating. The decision was by no way a dead certainty, and the reaction of the Rand on the announcement highlighted this point. There was immediate strength on the news, but reality soon stuck in, that despite this reprieve, the country still has lot of work to do to get itself back on the high ground. S&P will only deliver another scheduled update in six months time, which gives the country some time to right the economic and political wrongs, but Fitch is the next credit rating hurdle. They’re expected to table an update later this month, but with a stable outlook, there’s some expected breathing space for the country, despite being one notch above junk. Well known economist Kevin Lings gives his assessment of Friday’s decision below. – Stuart Lowman

By Kevin Lings*

On 3 June 2016, Standard & Poor’s confirmed South Africa’s sovereign international credit rating at BBB- (investment grade), but still with a negative outlook. The decision by S&P to leave South Africa’s sovereign credit rating unchanged was expected by many local economists (including STANLIB) although some market participants remained nervous ahead of the decision.

Importantly, S&P made no changes to South Africa’s domestic credit rating, which remains at BBB+, with a negative outlook. (See chart attached that shows the credit rating assigned to South Africa by the three major credit rating agencies, namely S&P, Fitch and Moody’s).

Sovereign credit rating SA June 2016

According to S&P, their key concerns about South Africa’s credit risk are low GDP growth, which could further negatively social cohesion in the country, as well as rising political tension. On the positive side, they welcomed the improvements in the provision of electricity, and government’s resolve to reduce fiscal deficits.

Importantly, in order for South Africa to maintain its investment-grade rating, the country needs to ensure four key developments, namely the provision of a reliable source of energy, labour market reform, clarity on the mining code, and cohesion within the executive branch of government.

In making their ratings decision, S&P made the following key points:

  • South Africa’s weak economic growth continues to be hurt by a combination of factors including adverse terms of trade, weak external demand, the drought and subdued mining and manufacturing output. S&P have revised down their GDP growth assumptions for South Africa to 0.6% in 2016 from 1.6% published in December 2015.
  • The socioeconomic dynamics of race and skewed income distribution have the potential to shift policy toward intervention and income redistribution, at the cost of headline GDP growth.
  • South Africa is expected to continue to maintain strong institutions such as the Public Protector and the Judiciary, which provide checks and balances.
  • South Africa has strong democracy with independent media and reporting.
  • On the fiscal side, the government is showing stronger resolve to reduce fiscal deficits. The nominal expenditure ceiling, while tight, can accommodate unforeseen expenditure pressures within the existing framework. Treasury tax collection targets have often performed better than suggested by nominal GDP growth, pointing to tax buoyancy that is somewhat resilient to weaker economic growth trends.
  • Although less than a 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.
  • South Africa’s contingent liabilities are limited. Nevertheless, the government faces risks from nonfinancial public enterprises with weak balance sheets, which may require more government support. Broader state-owned enterprise reform is under discussion but is not expected to be concluded this year or next.
  • The size of the current account deficit has narrowed in 2015 owing to the lower price of oil, weak domestic demand, and some export response from the mining and auto manufacturing sectors.
  • South Africa finances its current account deficits mostly with portfolio and other investment flows, which can be volatile. Such volatilities could result 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.
  • The SARB is viewed as being operationally independent of government and its policies are credible.

According to S&P, the key factors that allow South Africa to maintain an investment grade rating include S&P’s assumption that South Africa will experience continued broad political institutional stability and macroeconomic policy continuity. In addition, S&P assumes that South Africa will maintain fairly strong and transparent political institutions and deep financial markets. Importantly, these positive are somewhat offset by the need for further economic reforms, low GDP growth, volatile sources of financing, a structural current account deficit, and sizable general government debt.

S&P indicated that they could lower South Africa’s credit rating this year or next if policy measures do not turn the economy around. They could also lower the rating if they believe that institutions have weakened due to political interference that has affected the government’s policy framework. Furthermore, a downgrade is likely if net general government debt plus government guarantees to financially weak government-related entities together surpass 60% of GDP. In contrast, the key to S&P upgrading South Africa’s credit rating to a stable outlook is dependent policy implementation leading to improving business confidence and increasing private sector investment, that ultimately contributes to higher GDP growth.

Overall, S&P’s assessment of South Africa was less critical than we had expected, which is very encouraging. Instead, the tone was relatively well balanced, with S&P flagging both negative and positive factors. S&P is clearly impressed by national treasury’s intention and commitment to improving the country’s fiscal position. However, S&P made it clear that further economic and political reforms are required in order to lift the country’s growth rate and thereby avoid a ratings downgrade to below Investment Grade. This means South Africa has another 6 months to show progress in implementing measures that improve South Africa’s economic prospects. Ultimately, the country remains precariously close to another ratings downgrade. S&P’s next review South Africa’s credit rating is in December 2016.

The next key rating decision for South Africa will be by Fitch, later this month.

Fitch SA Credit Rating June 2016

  • Kevin Lings is chief economist at Stanlib.
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