Moody's left SA’s key credit ratings at investment grade (Baa3) as expected late last night, upgrading the sovereign’s outlook from negative to stable. The agency built the market, and perceived business sector, euphoria resulting from the election of Cyril Ramaphosa to ANC, then SA, President into its analysis.
Additionally, Moody’s said “(t)he recent change in political leadership appears to have halted the gradual erosion of the strength of South Africa's institutions. With changes in governance, a number of key institutions, including the Treasury, the South African Revenue Service (SARS) and key State-Owned Enterprises (SOEs) have embarked on the recovery of their earlier strength.”
It is the first of the three key credit rating agencies to revise up SA’s rating outlook (from negative to stable) since the change in leadership in SA. However, Moody’s is at care to point out the deterioration to SA’s key institutions, economic growth, public finances and investor confidence that has occurred under the previous regime.
It highlights that “recent years have seen a gradual erosion in the strength of some key institutions, with a correspondingly negative impact on economic and fiscal strength and on the effectiveness of policymaking. High and rising concerns regarding endemic high-level corruption, 'state capture' and pressures on the mandate and independence of key policy-making institutions such as the Reserve Bank have materially damaged economic confidence and effective policy-making, exacerbating the erosion in the government's balance sheet.”
“Examples of the erosion of the government balance sheet are diverse, but include the increasingly entrenched financial challenges facing key SOEs, the decline in the capacity of SARS to collect revenue for the government and, most recently, the absence of any clear policy direction in the Medium Term Budget Policy Statement (MTPBS) published in October 2017, a key driver of Moody's recent review of South Africa's credit rating.”
The recent halt to the deterioration of SA’s institutional framework forms the first driver of Moody’s rating rationale (of leaving SA on investment grade, with a stable outlook), the second is improved actual and, specifically, expected future economic growth performance, and the third the fiscal
adjustment plans of the Budget which should stabilise, then reduce the debt levels.
Specifically, Moody’s says “the prospect of higher than expected growth this year and next allows the government some additional fiscal and political space in which to pursue reforms.” And that there has been “a sharp recovery in business and consumer confidence, illustrated both in surveys, and by other indicators such as the recent recovery in the value of the rand.”
However, it warns “(w)hile confidence can dissipate quickly, if sustained through further actions, it offers the prospect of rising levels of investment in South Africa's economy and enhanced medium-term growth. The government recognizes the need to support improving confidence with steady progress on structural reform, including in the areas of mining, energy, the SOE sector and
competition. Future growth prospects will inevitably reflect its progress in those areas.”
On a more positive note, the 2018 Budget is seen to outline “a clear strategy for addressing rising fiscal pressures, with a front loaded, revenue-driven, fiscal adjustment, supported by material cuts in expenditures in this and subsequent years needed to finance, inter alia, rising expenditure on education
It is key that Moody’s recognises that the economy “has significant growth potential. A combination of growth, expenditure restraint and further improvements in the breadth of the revenue base and in collection capacity should, if pursued effectively, lead to the debt trajectory stabilizing in the next two to three years and ultimately reversing.” This forms the basis for the stable outlook.
A shift to a positive outlook, which signals a rating upgrade, will be dependent on deliverables including sustained robust economic growth, improved institutional strengths and meaningful fiscal consolidation – “a virtuous cycle I of economic growth, fiscal prudence and mounting social cohesion”.
Moody’s gives specific detail on the potential for a rating upgrade, stating “(t)he successful implementation of structural reforms to raise potential growth as well as stabilize and eventually reduce the debt burden, including through reforms to the SOE sector which reduce contingent liabilities, would put upward pressure on the rating.”
“In particular, reforms resulting in higher savings and investment rates and broad-based, sustainable, job-creating growth, alongside rebuilding of fiscal buffers would provide positive momentum to the rating. In reaching such a conclusion, Moody's would consider the longer-term ramifications of near-term fiscal and economic outcomes, as well as progress in enacting reform measures and resolving long-standing structural issues, including those relating to mining and agriculture.”
The rand has strengthened to R11.67/USD, R14.43/EUR and R16.21/GBP from R11.90/USD, R14.67/EUR and R17.02/GBP on Friday. The market cheer was limited however, as Moody’s warned that a downgrade can still materialise if “policy ineffectiveness continues to undermine confidence, growth and social cohesion, with inevitable consequences for the government's balance sheet”, should “the government's commitment to, or capacity to engineer, revived growth and debt stabilization I falter ”and if “SOE sector risks crystalli(se) I in a manner which raised the government debt burden and put it on a higher trajectory”.
Moody’s reviews SA again on 12th October 2018, and continues its biannual review process in 2019. In particular, it will be watching for “government's success in delivering planned structural reforms in the period between now and the 2019 Presidential elections, and to the impact of its actions or inaction on the investment climate and on near-term and potential growth.”