In its latest review, S&P left South Africa’s key credit ratings at sub-investment grade (foreign currency BB, local currency BB+ - both long-term) as expected this weekend, with the stable outlook reflecting the “view that economic growth will pick up modestly over the next year, while government debt will remain above 50% of GDP … (and) … that the government will pursue economic and social reforms”.

Specifically, the agency recognised that “(a)fter the recent political transition, authorities are pursuing key economic and social reforms, but … the economic and social challenges the country faces as considerable. South Africa's economic growth remains tentative, and the government's debt burden continues on a rising path.”

The rand has strengthened slightly to R12.43/USD, R14.52/EUR and R16.56/GBP from R12.48/USD, R14.55/EUR and R16.62/GBP on Friday. The market cheer was limited however, as S&P warned that it could lower the ratings if it “were to observe fiscal deterioration, for example, due to higher expenditure pressures or weaker economic performance."

The agency further took notice of the expropriation without compensation (EWC) debate in SA, highlighting that it “could also consider lowering the ratings if the rule of law, property rights, or enforcement of contracts were to weaken, undermining the investment and economic outlook.”

The agency recognises that “(i)t is still too early to tell how the process will unfold, but … (that it) … expect(s) … that rule of law, property rights, and enforcement of contracts will remain in place and will not significantly hamper investment in South Africa.” Should this change, and prove to be negative for economic growth, it will probably be negative for SA’s credit ratings.

It is important to note that S&P’s view on SA, and hence the rating it gives to SA’s perceived creditworthiness “reflects … (its) … consideration of the checks and balances embedded within South Africa's institutional framework, which includes a constitutionally independent judiciary.”

However, given that it says “(t)he government has also expressed its willingness to promote private-sector investment by removing policy uncertainty, improving competitiveness in economic sectors, and announcing fiscal measures to stabilize public finances”, S&P on balance does not seem worried that the EWC process will be particularly disruptive to the economy.

While we expect no credit rating downgrades this year from any of the three key credit rating agencies, Fitch, Moody’s or S&P, it is important to note that S&P is extremely clear in saying that it “(c)onsider(s) South Africa's fiscal position weak.”

As the fiscal assessment forms the cornerstone of any sovereign credit rating, this shows SA still has a long path before regaining its lost S&P investment grade ratings.Specifically, S&P “view(s) contingent liabilities as sizable.

This reflects the increased risk that non-financial public enterprises (NFPEs) could require further extraordinary government support than currently provisioned. In addition, plans to improve the underlying financial position of NFPEs with weak balance sheets may not be implemented in a comprehensive and timely manner.”

The agency “estimate(s) overall public-sector debt at 70% of GDP in 2018 (including central and local government, and debt of public sector companies).” Also very concerning is that “South Africa's … gross external financing needs are large, above 100% of current account receipts plus useable reserves.”

“The large external financing needs reflect the short-term external debt of the financial sector--predominantly trade finance facilities and deposits from multinational companies - at an estimated 7% of GDP. South Africa's overall net international investment position moved from a net liability to a net external asset position in 2015."

“However, this does not guard against possible large-scale capital outflows - particularly from South Africa's large equity and government bond markets.” SA remains at risk of global risk-off and so foreign investor sell-off of its portfolio assets. Since the global financial crisis, to April 2018, US$2.5trillion flowed into EMs in a relatively low US interest rate environment – but as the transition to neutral US interest rates becomes more advanced, the risk of outflows is heightened.

Indeed, S&P adds that it “expect(s) current account deficit to be slightly higher, averaging 3.2% of GDP over 2018-2021. The size of the current account deficit is relatively low by historical standards; it has been funded predominantly via volatile portfolio inflows. Foreign investors hold nearly US$20billion in government local currency debt. Such flows can be susceptible to changes in foreign investor sentiment, and interest rates in the U.S. are forecast to rise.”

Also looking forward, S&P “project(s) that net general government debt to GDP will increase to around 52% net of liquid assets by the fiscal year ending March 2021. Debt-servicing costs, measured by the ratio of interest to revenues, will remain close to 12% of revenues.

South Africa's public finances still face risks from higher public-sector wage agreements than budgeted, and potential unbudgeted support to SOEs with weak balance sheets, which are not included in the current fiscal framework.

”Furthermore, “(w)hile the policy framework remains broadly the same as previous ANC administrations, there seems to be renewed impetus to the reform agenda. The new leadership is working on measures to enhance governance at state-owned enterprises (SOEs), reviewing weak SOEs' balance sheets to enhance financial sustainability.”

Additionally, S&P “anticipate a pick-up in private-sector fixed investment, while lower inflation could boost households' disposable income, resulting in higher household consumption. We now estimate economic growth to average at least 2% over 2018-2021, which is still below 1% per capita.”

Indeed, S&P “estimate(s) that among the 20 major emerging markets, only Qatar will show slower per capita growth in 2018. … We estimate South Africa's GDP per capita at US$7,200 in 2018.”

S&P emphasise that it “could lower the ratings if … (it) … were to observe fiscal deterioration, for example, due to higher expenditure pressures or weaker economic performance. … (It) could also consider lowering the ratings if the rule of law, property rights, or enforcement of contracts were to weaken, undermining the investment and economic outlook.”

S&P reviews SA again on 23rd of November 2018, and Moody’s on 12th October 2018. Fitch’s timing is indeterminate but likely around the same time. The agencies are then set to continue their bi-annual review processes in 2019 and beyond.

S&P has highlighted that it “could raise the ratings if economic growth or fiscal outcomes strengthen in a significant and sustained manner compared with … (its) current projections.”

“Ratings upside could also arise if the risks of a deterioration in external funding sources were to subside, and external imbalances declined. … (S&P) could also take a positive rating action if policymakers were to introduce structural economic reforms that delivered improved competitiveness and employment.”