The most recent decision
Fitch affirmed South Africa's investment grade rating in June 2016. Long-term foreign and local currency Issuer Default Ratings (IDR) have been affirmed at BBB- and BBB respectively. The stable outlook remains unchanged.
Key drivers
The BBB- rating is a reflection of low trend GDP growth, significant fiscal and external deficits, and high debts levels. These are balanced by strong policy institutions, deep local capital markets and favorable government debt structure.
According to Fitch, political risks have increased since the last review in December 2015, and this political risk is considered mainly in terms of its impact on the economy and public finances.
The five-year average GDP growth is at 2.2% compared to a BBB median of 3.3%. Hence the trend of the GDP growth of South Africa remains low compared to its peer. GDP growth was 1.2% in 2015 and Fitch predicted that it is likely to decrease to 0.7% in 2016 before picking up to 1.5% in 2017. This slow GDP growth is due to the constraint in electricity supply as well as the worsening investment climate and conflicting labor relations.
However, the government has made considerable progress in addressing the issue of power supply with no load shedding so far this year, the maintenance management has improved and more power sources have been added to the grid.
Furthermore, other government efforts to improve growth are likely to have a marginal effect. For instance, the use of more private sector funds to build infrastructure for renewable power program, the creation of a public-private fund to support small and medium enterprises, the reduction of uncertainty and administrative barriers for companies. On the other hand, some initiatives such as the planned national minimum wage, the recently introduced Expropriation Bill and the planned revision of the Mining Charter could frustrate investment according to Fitch.
The current-account deficit was 4.3% of GDP in 2015 compared to a BBB median of 1.4% and Fitch expects only a moderate improvement for 2016 due to lower imports as a result of weak domestic demand and the recent substantial depreciation of the rand. However, the impact of the improvement in export volume over the last 3 quarters has been partly offset by falling exports prices in dollars due to the decline in commodity price.
Net external debt was 13.6% of GDP in 2015 compared to a peer median of 3.9%. The risks are reduced by a flexible exchange rate and the favorable composition of external debt which is mostly in local currencies and has long maturities. However, the fiscal deficit remains high, with a deficit of 3.9% of GDP in the fiscal year ended 31 March 2016. The government in the fiscal year 2017 budget introduced tax measures to raise tax revenue by 0.4 % of GDP in 2016/17.
Further measures will be introduced over the coming two years, bringing tightening to around 1 percent of GDP per year by 2019 fiscal year. The government expects this to bring the deficit to 3.2 percent of GDP in 2017, 2.8 percent of GDP in 2018 and 2.4 percent of GDP in 2019 so that the central government debt to GDP would rise to 51 percent of GDP in 2018 fiscal year.
However, achieving these targets will be challenging given that GDP growth is likely to be low. Pressures to increase expenditure are rising due to increasing dissatisfaction with public service delivery. The decreasing support for the ruling party may also add to the challenge of bringing down the budget deficit. Revenue estimates underlying the deficit expectations have been conservative and the National Treasury has a strong track record of keeping expenditure below the ceilings. Fitch expects the deficit to be at 3.3% of GDP in 2017 fiscal year and 3% in 2018 expecting that the general government debt could rise to 53.3% of GDP in 2018.
On the other hand, inflation increased to 7% in February 2016 before slowing down to 6.2% in April, above the inflation target of 3%-6%. The South African Reserve Bank has reacted by raising interest rates in total by 200 basis points to 7% since 2014. Contractionary monetary policy enforced by the SARB shows its independence and commitment to containing inflation.
Governance indicators are slightly stronger than structural indicators such as per capita income, which are weaker than those of BBB category peers. The banking sector remains sound due to careful regulation although the weak economy will gradually affect asset quality and profitability.
Possible reasons for a rating change
The reasons for a rating downgrade would include:
- Weakening fiscal policy, for instance an upward revision of expenditure ceilings leading to a failure to stabilize the ratio of government to GDP or an increase in contingent liabilities.
- Failure of GDP growth to recover sustainably, including lack of policy change to improve the investment climate.
- Increasing net external debt to levels that lead to financial strains.
- High political instability that negatively affects the economy or public finances.
Motives for a rating upgrade would include:
- A track record of improved growth performance strengthened by the successful implementation of growth-boosting structural reforms.
- A considerable reduction in the budget deficit and in the government debt to GDP ratio.
Agathe Fonkam
Researcher
agathe@hsf.org.za
