Ratings: Why SA is stuck in junk
Despite President Cyril Ramaphosa’s inauguration, S&P takes a sceptical view of SA’s economic reform prospects and forecasts a glacial recovery
Six months ago, S&P Global Ratings held the constructive view that after the 2019 elections, SA’s economic reforms would begin to pay off, boosting growth above 2% over the medium term and helping to rein in government debt.
Not any more. The ratings agency’s latest review, delivered over the weekend, is decidedly more bearish.
S&P now believes SA’s overall economic reform efforts are likely to remain "lacklustre" over the next few years. This will limit the pick-up in economic growth and keep it close to zero on a per capita basis.
Despite this sombre assessment — and the fact that S&P has also lowered SA’s growth and fiscal projections — it has held SA’s foreign currency debt rating at BB (two notches into junk grade) and the local currency debt rating one notch higher, at BB+, with a stable outlook.
Six months ago, S&P was forecasting that SA would grow by 1.8% in 2019, and 2.3% in 2020 and in 2021, averaging 2.1% over the three years.
It now expects real GDP growth of 1% in 2019, rising to 1.8% in 2020 and 2% in 2021, averaging just 1.6% over the three years.
Not only has SA’s growth trajectory slowed, but the country has also incurred significant fiscal slippage over the past six months. This is mainly because the National Treasury has to fund a R69bn three-year bailout for Eskom.
As a result, S&P now expects general government net debt to grow by 4.7% (previously 4.5%) of GDP over the medium term, to hit 55.5% of GDP by 2022 (previously 53% by 2021). But it estimates that once the debt of local government and state-owned enterprises (SOEs) is included, SA’s overall public debt has already reached 75% (previously 71%) of GDP — five percentage points above the high-risk threshold associated with debt distress in other emerging markets.
The deterioration helps to explain why S&P hasn’t raised SA’s ratings outlook from "stable" to "positive", despite believing that, with the election behind him, President Cyril Ramaphosa will redouble his efforts at reform.
S&P expects these to focus primarily on cutting costs, slimming the ministerial head count, improving SOEs and tackling graft.
"However, the government will likely continue to shy away from difficult and contentious issues such as widespread staff retrenchments in SOEs and tackling the labour unions," S&P says in its ratings review.
As such, it expects the reforms to have only a slight impact on investor confidence, investment and growth this year.
"Overall reform efforts are likely to be lacklustre and unlikely to be significant enough to drive strong GDP growth," S&P concludes.
Abiding scepticism about SA’s ability to undertake meaningful economic reform is emerging as the consensus view, given that Ramaphosa remains hamstrung by factionalism within the ANC and is unable to make unilateral decisions on contentious economic policy issues.
Fitch Ratings, which like S&P junked SA’s ratings in 2017, is also of the view that Ramaphosa’s stimulus measures and other reforms are unlikely to significantly alter SA’s growth trajectory.
Moody’s remains the outlier among the three main ratings agencies, having kept SA one notch above junk status. But it also expects structurally low growth to continue to weigh on the country’s credit profile. In fact, Moody’s medium-term growth projections are even more bearish than S&P’s — it expects SA’s real GDP growth to rise to 1.3% this year, but to converge at a mere 1.5% in the following years.
It warned SA in a research note immediately after the elections that unless Ramaphosa implements effective policy change, "the sovereign’s credit profile will most likely continue to erode, with fiscal strength weakening and growth remaining low". In other words, it is likely just a matter of time before Moody’s also junks SA’s ratings.
Responding to S&P’s review, the Treasury said in a statement that the government "fully recognises" S&P’s assessment of the challenges and opportunities.
"The main focus for government remains to regain SA’s investment-grade status to make the country an attractive investment destination," it added. "This will be achieved by enhancing policy certainty and credibility, implementing growth-enhancing economic reforms, lowering the debt burden as well as restoring good governance and financial stability at public institutions and SOEs, specifically Eskom."
In its current form, Eskom is not financially sustainable, nor is it able to meet the country’s electricity needs.
S&P notes that electricity shortages in the first quarter of the year, caused by operational issues at Eskom, alongside weakness in mining and manufacturing, dented performance in most sectors and will weigh on growth.
SA’s ratings with S&P are constrained by the weak pace of economic growth, particularly on a per capita basis, as well as the country’s large and rising fiscal debt burden, and significant contingent liabilities. The latter consist mainly of the government’s guarantees to SOEs, which constitute a commitment to take responsibility for SOEs’ loans in the event that they default.
Ramaphosa remains hamstrung by factionalism within the ANC and is unable to
make unilateral decisions on contentious policy issues
In total, the government has guaranteed R483bn of SOE debt. Of this amount, it is exposed to about R372.4bn. Eskom alone accounts for R350bn of the total guarantees. As of the February budget, Eskom had drawn against R294.7bn of this amount.
S&P views SA’s contingent liabilities as "sizeable" and fears that there is an increased risk that the nonfinancial public enterprise (NFPE) sector, and Eskom in particular, could require more extraordinary government support than is provided for in the budget.
"In addition, plans to improve the underlying financial position of Eskom and other NFPEs with weak balance sheets may only deliver results over time," it warns.
S&P says it could lower SA’s ratings if it sees continued fiscal deterioration and the crystallisation of contingent liabilities, or if the country’s economic performance is structurally weakened or external financing pressures mount.
It could also consider lowering the ratings if the rule of law, property rights or enforcement of contracts weaken significantly, undermining the investment and economic outlook.
S&P continues to hold a sanguine view of SA’s land reform process, mainly because it takes comfort from the "checks and balances embedded within SA’s institutional framework, which includes a constitutionally independent judiciary".
In S&P’s previous review it stated that it did not expect a policy of expropriation without compensation "to significantly hamper investment levels". It has dropped that wording in the latest statement. Now it acknowledges that though the president has stated that any expropriation would follow due process and agriculture should not be damaged, "such reform has worried some investors".
Nevertheless, S&P still expects land and property expropriation to move slowly and believes that deals will remain subject to the courts’ scrutiny, and that the rule of law and enforcement of contracts are safe.
It also expects any moves to nationalise the Reserve Bank to take time and for the Bank to retain its operational independence over its forecast period (until the end of 2022).
S&P regards SA’s monetary flexibility as a key credit strength, as it does SA’s well-capitalised and regulated financial sector, its deep capital markets and relatively moderate external debt. The fact that 88% of SA government debt is denominated in rands helps to shield the country from exchange rate shocks. This is seen as strongly credit positive by all the main ratings agencies.
However, as of last month, nonresidents held almost 40% of the government’s rand-denominated debt.
While the large presence of international investors in SA’s debt markets helps improve liquidity and can lower the government’s cost of funding, S&P notes that it also means the economy is vulnerable to global emerging-market sentiment and interest rate movements.