S&P downgrades SA’s foreign and local currency ratings. Moody’s puts SA’s ratings on review for possible downgrade.

S&P has again cut SA’s foreign and local currency ratings by one notch each to BB and BB+ respectively. The rating outlook on both counts has been revised to “stable” from “negative” as the country’s fiscal metrics (after the sharp deterioration seen in the MTBPS) are now forecast to remain relatively unchanged in 2018, while political instability could abate following the ANC’s elective conference in December.

The downgrade mainly reflects the impact of a further deterioration in the country’s economic growth outlook and the government’s fiscal flexibility. S&P lowered its real GDP growth projections to 0.7% in 2017 and 1% in 2018, from 1% and 1.3% respectively, noting this is expected to lead to an “unprecedented shortfall in tax receipts in 2017-18.”

While S&P expects measures to be announced in the February 2018 budget to help offset some of the recent fiscal slippage, it does not believe these will be sufficient to stabilise public finances in the long haul. It also remains very concerned about the persistent deterioration in per capita income growth, with SA’s 2017 outcome now being the third lowest among 20 major emerging markets (after Qatar and Venezuela).

It further notes that inequality has continued to rise despite efforts by the government to reduce poverty, which could, along with the pending 2019 national elections, be an impediment to fiscal consolidation. As the political agenda has prevented positive policy actions, a potential offset to the growth dampening impact of fiscal consolidation has failed to materialise. Additional fiscal tightening may therefore further weaken growth and so tax revenue. The weak financial state of SOEs presents another major risk to government finances.

S&P has accordingly revised up its forecast for the budget deficit to 4.4% of GDP for FY2017/18, easing to only 3.6% by FY20/21.  Importantly it no longer sees government debt levels stabilising, instead projecting it to end 2020 at around 57%, up about 5 percentage points since 2016.

Further downgrades will occur if:

  • Economic growth and the fiscal performance deteriorate substantially further and/or the strength of SA’s institutions comes into question

Ratings could improve if:

  • Economic growth and fiscal performance improve by more than what S&P currently forecasts
  • External imbalances decline
  • Substantive policy reform lifts capital formation, job growth, competitiveness and ultimately potential GDP growth

Shortly after S&P’s announcement, Moody’s kept its ratings on hold, putting the country’s Baa3 (investment grade) rating on review for possible downgrade, citing similar fiscal and growth concerns. Moody’s is the only agency that rates SA’s foreign and local currency as investment grade.

The downgrade reprieve is aimed at allowing it the opportunity to assess the country’s willingness and ability to implement fiscal consolidation measures as well as much needed structural reform. Moody’s, however, warned that failure to address either of these two issues, coupled with any further erosion of the credibility and independence of core state institutions (SARS, Treasury etc) would see ratings lowered.

While another rating’s downgrade has all along been factored our forecasts, the downgrade by S&P has brought forward the timing of anticipated capital outflows as the country is no longer eligible for inclusion in the Barclays Aggregate Bond Index (which houses approximately R40bn of SA government debt). The resultant capital outflows should trigger a somewhat weaker exchange rate (USD/ZAR depreciated by 2% after the announcement), a slight upward adjustment in our inflation trajectory, while also raising the prospect of earlier than initially anticipated interest rate hikes.

Significant event risk remains over the coming months, most notably, the ANC elective conference. While we hope for greater policy and political certainty after December, for now we assume a continuation of the current trajectory, and so the possibility that Moody’s follows both S&P and Fitch, lowering SA’s credit rating to sub-investment grade.

This would ultimately exclude SA from participation in the Citi Bank World Government Bond Index, which would potentially see even greater capital outflows and currency stress.