Is SA out of the downgrade woods?

14 August 2018

South Africa is the only major emerging market in recent years not to be downgraded to below investment grade by ratings agency Moody’s, once placed on review. This means we don’t join the ranks of Russia, Brazil and Turkey and instead we can chart our own course. But whereto from here?

On 23 March 2018, Moody’s announced that it retained the sovereign credit rating of the government of South Africa at Baa3 (BBB- equivalent). More importantly, Moody’s revised its outlook for South Africa’s credit rating to ‘stable’ after it commenced a review for downgrade on 24 November 2017.

The March 2018 announcement capped a remarkable turnaround in the fortunes of South Africa’s sovereign credit rating following years of downgrades which culminated in Standard & Poor’s and Fitch downgrading South Africa’s credit rating to below investment grade on 3 April 2017 and 7 April 2017 respectively.

The main concern regarding a further credit rating downgrade by Moody’s centred on the exclusion this would have caused from international bond benchmark indices. The main index is the Citi World Government Bond Index and such a move would have forced international investors tracking this index to sell between US$6 billion and US$9 billion of South African local currency bonds. Such a material sale of bonds would likely have resulted in increased bond yields and currency weakness. Fortunately, this has now been averted for the foreseeable future.

How was the Moody’s downgrade avoided?

Following the election of Cyril Ramaphosa as President of the ANC on 18 December 2017, and ultimately his appointment to the State Presidency on 15 February 2018, there has been a marked change in sentiment towards the country. Though the optimism has been tempered to some extent by certain compromises made during the announcement of Ramaphosa’s first cabinet reshuffle on 26 February 2018, coupled with increased discussions on land reform, a more buoyant mood persists.

In recent months, there have been a number of developments which have started to stabilise ailing state-owned companies (SOCs), restore credibility to key ministries, and arrest the erosion at essential government institutions such as the South African Revenue Service (SARS). The much-needed changes to SOCs commenced with the announcement of a new Board of Directors at South African Airways (SAA) in October 2017, thereafter a CEO with extensive corporate experience, in the form of Vuyani Jarana, was appointed to SAA in November 2017. This was followed by the announcement of a new board of directors, along with a credible interim management team, at Eskom in January 2018.

During Ramaphosa’s cabinet reshuffle in February 2018, well-regarded technocrats were appointed to key ministries, including: Nhlanhla Nene as Finance Minister and Pravin Gordhan as Minster of Public Enterprises, where he will be entrusted with the finances of some of the largest SOCs, including Eskom, Transnet and Denel. Finally, the suspension of Tom Moyane as Commissioner of SARS in March 2018 was widely welcomed by the market.

The above changes were complemented by the 2018 Budget Speech, which was delivered by Nene’s predecessor as Finance Minister, Malusi Gigaba. The Budget Speech provided an element of fiscal consolidation in the form of spending cuts and tax hikes, and more specifically the percentage point increase in the value added tax (VAT) rate, to 15%. The VAT hike presented in the Budget Speech indicated a more pro-active fiscal policy response by the government to addressing its financial constraints, which have gone beyond the expenditure cuts traditionally relied upon to reign in any gaps in the fiscus.

As part of its March 2018 statement, Moody’s indicated that the recent actions taken by the South African government had halted the deterioration in South Africa’s institutional framework. In addition to the government actions, Moody’s credited the strength and independence of South Africa’s media, civil society and institutions (including key bodies such as the South African Reserve Bank) as critical in sustaining the country’s credit profile over time.
Moody’s acknowledged the strong commitment and clear strategies of the South African government to stabilising government finances through meaningful actions on both the revenue and cost side. Finally, Moody’s indicated that the recovery in business and consumer confidence increased the prospects of rising levels of investment and ultimately improved economic growth scenarios over the medium term.
Where have we come from?

Moody’s assigned a credit rating as high as A- to South Africa as recently as September 2012. Since then, South Africa faced a number of challenges which led to the deterioration in the country’s credit rating. The accompanying table illustrates a number of factors raised by Moody’s in recent times when taking negative credit decisions on the South African credit ratings.

The table illustrates that the problems being faced by South Africa have not changed much over time and, up to this point, little has been done to address these challenges in a meaningful manner.

SOUTH AFRICA’S CREDIT RATING HISTORY

Where are we currently?

Despite Moody’s retaining its credit rating and the outlook being revised to ‘stable’, the ratings agency raised familiar concerns as credit challenges facing South Africa during its March 2018 announcement. They are as follows:

• Political and social divisions that generate policy uncertainty and impede structural reforms;
• Low growth and high levels of unemployment; and
• Increased government debt levels and contingent liabilities related to SOCs.
     

It is due to these persistent challenges that Moody’s may still reconsider its view on the South African credit rating at some point in the future, particularly in the event that the current improved sentiment does not translate into meaningful reforms and economic growth.

In summary

The risk of imminent credit rating downgrades have been averted. However, for South Africa to ensure it retains its investment grade rating from Moody’s, and is considered for rating upgrades by other rating agencies, it is imperative that Ramaphosa and his new cabinet implement further changes to address the challenges being faced by South Africa. Issues top of mind include the new Mining Charter and the strengthening of governance structures at SOCs through the appointment of qualified boards. Finally, opening the capital markets for SOCs to allow them to issue new funding to address the rising liquidity pressures (an additional threat to the sovereign balance sheet) should be high on the priority list.

South Africa has been given a stay of execution. The question is what we do with it.