The most recent decision
In June 2016, S&P decided to keep its rating for South Africa at BBB- with a negative outlook. This is a huge relief for the country, which has just missed junk status. The unchanged rating shows that the Minister of Finance along with the Treasury, business and unions have done enough to save the country from junk status.
Low GDP could eventually weaken the government’s social contract with business and labour. Political tensions are increasing the vulnerabilities in the country’s sovereign credit profile. The energy sector has shown some improvement and this will reduce some of the economic bottlenecks pending finalisation of labour and mining reforms, and this could lead to a positive confidence shock.
The weak economic growth of South Africa relative to peers in the same categories continues and this is due to a combination of factors. On the external front, unfavourable terms of trade and weak external demand have created challenges. Domestically, drought and subdued mining and manufacturing output along with structural constraints are the main negative factors. As a result of these factors real GDP growth of South Africa was revised down to 0.6% in 2016 from 1.6% in December 2015. As the weather patterns and terms of trade return to mean levels, economic growth is likely to improve.
However, the government is showing some improvement in reducing fiscal deficits at a faster pace than expected by S&P. Hence BBB-/A-3 foreign currency and BBB+/A-2 local currency sovereign credit ratings on South Africa were affirmed. The negative outlook remains and this reflects the unfavourable consequences of low GDP growth. A lower rating for the country could be expected in the coming year if policy measures do not improve the state of the economy.
Reasons for affirming ratings
1. Provision of a reliable source of energy. The state owned power utility has maintained the energy supply through a better maintenance program, and has been able to manage demand in peak periods with the help of its new plants and independent power producers. These measures helped eliminate load shedding which was widespread in 2015.
2. Labour reform. Persistent strikes in mining and some manufacturing sectors coupled with less flexible Labour laws and high youth unemployment continue to be structural weaknesses to the South African economy.
3. The mining code. Negotiations on Black Economic Empowerment are sensitive and according to S&P, negotiation between the government, private sector and unions could take longer and, even if concluded, implementation could be challenging. However, these challenges are not insuperable and successful conclusion could help improve confidence and investment.
4. Cohesion of the executive branch. If political conditions continue as they are, this could affect more investors’ confidence than inconclusive labour or mining sector reform. Hence political developments have to be monitored.
S&P projects that the economy will grow by 1.5% in real terms in 2017 and rise above 2% only by 2019, assuming increases in interest rates by the US Federal Reserve will not disturb emerging markets and that China will remain moderately supportive of world growth. S&P believes that South Africa will continue to maintain strong institutions such as the public protector and the judiciary which provide checks and balances.
On the fiscal side, the government is showing improvements in reducing fiscal deficits with targets of 3.2% of GDP this year, 2.8% in 2017 and 2.4% in and 2018. Consolidation is achieved through a combination of expenditure and revenue measures.
On the expenditure side, nominal expenditure ceiling can accommodate unforeseen expenditure within the existing framework as it has been the case this year with extra outlays on university fees.
However, on the revenue side, government has introduced tax increases on trade and excise duties. Treasury tax collection targets have often performed better than expected nominal GDP growth.
General government debt, net of liquid assets is expected to stabilise around 48% of GDP in 2018-2019, from 45% of GDP in 2015. The Interest expense projection for this year is 11% of government revenue. Debt-servicing costs could be higher than estimated if domestic interest rates continue to rise due to a repricing of the country’s risk or changing inflation expectations.
South Africa is facing contingent liability risks from nonfinancial public enterprises with weak balance sheets. They may need more direct government support.
Growth in real exports is expected to be slow in the next three years and supply side constraints to production continues, while on the other hand import growth may be reduced with the weak currency and weak domestic economy.
Financing of South African current account deficits mostly comes from portfolio and other investments flows, which can be volatile and this volatility could be due to: global changes in risk; foreign investors reviewing prospective returns when growth or policy slowdown occurs in the country; or increasing interest rates in developed markets.
The South African Reserve Bank is operationally independent and its policies are credible. The Reserve Bank makes use of an inflation-targeting framework for its monetary policy as well as open market operations to manage liquidity and sterilize its purchases of foreign inflows. Despite lower oil prices, the weak exchange rate and higher electricity prices have increased inflationary pressures and the central bank expects inflation to remain outside the 3%-6% target range in 2016 and early 2017.
However long-term currency sovereign rating on South Africa is two notches above long-term foreign currency sovereign rating due to:
- A floating currency supported by independent monetary policy
- An active local current fixed-income market
- Prudent fiscal policy
S&P ratings are supported by the assumptions that South Africa will continue to maintain good broad macroeconomic policy, that the country will maintain fairly strong and transparent political institutions, and that financial markets will remain deep. On the other hand, the ratings are constrained by the need for further reforms, low GDP growth, volatile sources of financing, current account deficits, and rising government debt.
Reasons for a possible change in the outlook
- A downgrade by Standard and Poor’s could occur if: GDP fails to improve in line with agency’s current expectations
- Wealth levels continue to fall in US dollar terms
- Weakening institutions as a result of political interference affect the government policy framework
- General government debt and guarantees to weak government-related entities exceed 60% of GDP throughout the forecast period.
- Fiscal flexibility is reduced
A stable rating will result if policy implementation leads to the improvement of business confidence, increasing private sector investment, and contributing to higher GDP growth.
Agathe Fonkam
Researcher
agathe@hsf.org.za
