05 Jun 2017

Rand strengthens as S&P and Fitch leave SA's ratings unchanged as expected, but S&P’s negative outlook signals further downgrades for SA sovereign debt

Annabel Bishop

Chief Economic

The rand has strengthened to R12.69/USD, R14.29/EUR and R16.35/GBP from Friday’s close of R12.78/USD, R14.45/EUR and R16.39/GBP. Fitch and S&P affirmed SA’s credit ratings last week, and global risk-on has also boosted the local currency’s performance.

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The long-term, sovereign debt ratings (LSD) delivered in April 2017 of BB+ from Fitch for both LC (local currency) and FC (foreign currency), and LC BBB- and FC BB+ from S&P, were affirmed (unchanged) for South Africa in these scheduled reviews.

Fitch’s outlook remains stable, meaning no further ratings action is being considered. S&P maintained its negative outlook, signalling the next move will likely be a downgrade - we expect to BB+ for LC LSD delivered next year if S&P’s outlook is not changed (the risk of S&P BB for FC LSD remains).

The ratings rationale from S&P include “the weak pace of economic growth and limited fiscal flexibility, with a high stock of government debt”, “public sector debt at 70% of GDP in 2017” “overall guarantee utilizations will reach … (R)500 billion (about US$38.5 billion) in 2020, or 10% of 2017 GDP.”

S&P is worries that “political risks will remain elevated this year, which could distract from economic growth-enhancing priorities, slow the pace of fiscal consolidation, and weigh on investor and consumer confidence, more than we currently project”. “If fiscal and macroeconomic performance deteriorates substantially from our baseline forecasts, we could consider lowering the ratings.”

Fitch’s rating drivers show “South Africa's ratings are weighed down by low trend GDP growth, sizeable contingent liabilities and deteriorating governance”.

Fitch notes that  “(a) cabinet reshuffle at the end of March, which triggered an earlier downgrade of South Africa's ratings, is likely to undermine governance of state owned enterprises (SOEs), weaken fiscal consolidation and reduce private sector investment as a result of weaker business confidence.”

In particular “(w)hile efforts to improve the SOE governance framework will continue, implementation decisions, for example on appointments of senior SOE management, will hamper these efforts and could lead to weaker financial positions of SOEs and higher contingent liabilities for the government.”

On the political front Fitch says “(i)nfighting within the ANC will remain particularly strong ahead of the electoral conference in December 2017, when the ANC will select a new party president. The new party leader will likely become the country's president after national elections in 2019 or earlier”.

Fitch continues “(e)ven after the electoral conference, policy will still be influenced by competing factions in the ANC and the government will juggle multiple complex policy objectives, in particular improving business confidence and addressing the high degree of inequality.”

SA’s rand denominated issuance is around 90% and hard currency 10%. Downgrades raise borrowing costs, undermine investor confidence (including fixed investment and so GDP growth), likely reduce the attractiveness of SA bonds at auction, and so negatively impact SA's ease of funding. This in turn has a negative impact on SA’s government finances.

On the positive side Fitch noted “deep local capital markets, a favourable government debt structure and a track record of fairly prudent fiscal and monetary policy” and S&P “the country's high monetary flexibility, which we view as a strength, and an improving external position.”

Adding that “individually or collectively” “substantial strengthening in trend GDP growth”, “(a)n improvement in governance that is supportive of public finances and the business climate” and “(a) marked narrowing in the budget deficit and a reduction in the government debt/GDP ratio” could result in positive rating action.

S&P said “(w)e could revise the outlook to stable if we see political risks reduce and economic growth or fiscal outcomes strengthen compared with our base-case projections.” Such an outcome would avoid the credit rating downgrade that this agency is currently signalling will occur otherwise by its negative outlook.

S&P is scheduled to next deliver its country credit rating review on SA on 24th November 2017. Moody’s most recent rating review on SA is still outstanding. We continue to expect both a LC and FC LSD downgrade from Moody’s with to BBB- anytime within the next few weeks.

Should SA lose all its LC investment grade (IG) credit ratings from the three key agencies it will exit the Citibank WGBI index, with SA estimated to see an outflow of R80bn to R130bn, which would cause the local currency to depreciate markedly to our down case. SA bonds would then fall into the WGBI’s additional market’s index.

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