Notes from Kevin Lings about S&P’s latest credit rating report

On 2 December 2016, Standard & Poors Global Ratings 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 some local economists (including STANLIB) although most analysts and financial market participants were very nervous ahead of the decision. 

Importantly, but not unexpectedly, S&P lowered South Africa’s domestic long-term local currency rating to 'BBB' from 'BBB+'. According to S&P, the decision to downgrade South Africa’s domestic credit risk reflect the fact that the government’s financing needs are increasing beyond previous base-case expectations, while the proportion of rand turnover in the global foreign exchange market has fallen over the last three years. In addition S&P are concerned that political events have distracted from growth-enhancing reforms and persistently low GDP growth continues to dampen per capital wealth levels and South Africa’s fiscal performance.

The key positives and negatives about South Africa, as highlighted by S&P are as follows:

Key concerns from S&P:

  • South Africa’s pace of economic growth remains a big concern, especially the fact that GDP per capita is falling. While the government has identified important reforms and supply bottlenecks delivery has been piecemeal.
  • South Africa’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.
  • Political tensions are still high. Furthermore, in-fighting and contestations are increasing in the run up to the ANC’s December 2017 elective conference. The ongoing tensions and the potential for event risk could weigh on investor confidence and exchange rates, and potentially affect government policy direction.
  • South Africa’s gross external financing needs are large, averaging over 100% of current account receipts (CARs) plus usable reserves.
  •  Real exports growth is likely to be slow over 2016-2019 on persistent supply side constraints to production. Nevertheless, a fall-off in imports due to the subdued domestic economy should help the current account deficits average below 4% of GDP over 2016-2019.
  • South Africa still funds part of its current account deficits with portfolio and other investment flows, which can be volatile.
  • The South African government faces risks from non-financial public enterprises due to their weak balance sheets. This may require more government support than is currently assumed.
  •  Although less than one-tenth of the South African 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, andrises in developed market interest rates.

Key positives from S&P:

  • South Africa’s electricity sector has improved, with no load shedding since winter 2015 reflecting new capacity and lower demand.
  • The government has set up a commission into minimum wages, which has provided a starting point for negotiations with business and labour unions. Other implemented labour measures have given more power to labour tribunals to resolve disputes. Prolonged and damaging strikes are likely to be curtailed over the next two to three years because the gold and platinum sectors signed multiyear wage agreements.
  • South Africa has a strong democracy with independent media and reporting. S&P also argues that South African will maintain its institutional strength in the judiciary, which provides checks and balances and accountability where the executive and legislature has appeared less willing to do so.
  • Despite the weak economic environment constraining tax revenue collections, S&P believe the government remains committed to a fiscal consolidation path over the medium term through expenditure and revenue adjustments. The budget 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.
  • The government has delayed for two decades plans to finance and build nuclear power plants, which could have negatively impacted the fiscal metrics.
  •  South Africa continues to pursue a floating exchange rate regime. The SARB does not have exchange rate targets and does not defend any particular exchange rate level. The SARB is viewed as being operationally independent and its policies as credible.
The South African banking sector’s performance has remained reasonably strong.

S&P indicated that they could lower South Africa’s credit rating next year if:

  • GDP growth or the fiscal trajectory does not improve in line with current expectations, for example if South Africa enters a recession in 2017 or wealth levels continue to decline in US dollar terms.
  •  Institutions weaken due to political interference affecting the government's policy framework.
  • Net general government debt and contingent liabilities related to financially weak government-related entities exceeded current expectations.

 S&P indicated that they could move the rating outlook to neutral from negative if:

  • Policy implementation leads to improving business confidence and increasing private sector investment, and ultimately contributes to higher GDP growth and improving fiscal dynamics.

Overall, S&P’s assessment of South Africa was fairly well balanced and fair. Most of the negatives flagged by S&P are well known and extensively debated, while the long-list of positives factors is a welcome stand-out feature of S&P’s review compared with recent statements by Fitch and Moody’s. It is clear that S&P’s main concerns remain SA’s sustained low GDP growth rate, the risk that political tensions lead to a further deterioration in economic activity as well as a weakening of various fiscal parameters and that the State Owned Enterprises continue to place and excessive burden on government’s contingent liabilities.

It appears that S&P is 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. The net result is that 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 from all three of the credit rating agencies.

It is perhaps worthwhile to note that earlier this year Standard & Poor’s published their bi-annual review of sovereign credit rating trends around the world. According to this review global sovereign creditworthiness has declined since the onset of the global financial crisis in 2008. Just below 52% of all rated sovereigns are investment grade ('BBB- or above). This ratio is at the lowest level it has ever been. The average long-term sovereign credit rating has fallen by just over one notch to between 'BBB-' and 'BBB', compared with just below 'BBB+' in mid-2008. Furthermore, negative outlooks outnumber positive outlooks, and the outlook balance (positive minus negative outlooks) has dropped significantly, to -30 from -4 in mid-2015. This constitutes the most negative 12-monthly swing in the outlook balance since June 2009.

It is, therefore, clear that the ratings downgrade South Africa has experienced in recent years is not exceptional when compared with the global trend. In addition, the rating downgrades have been especially evident amongst commodity exporters. Earlier this year a Fitch rating review report highlighted that “seven of the 10 most commodity-dependent nations rated by Fitch have been downgraded in 2016 or are on negative outlook.” This does not mean that South Africa should be complacent about further downgrades. Instead, it is critical that the policy officials do all they can to help South Africa avoid any further downgrades.