“The downgrade reflects our expectation of lackluster GDP growth in South Africa, against a backdrop of relatively high current account deficits, rising general government debt, and the potential volatility and cost of external financing, the ratings services said in a statement.
Standard & Poor also lowered the long-term local currency rating to 'BBB+' from 'A'.
“We also lowered the short-term foreign currency rating to 'A-3' from 'A-2' and affirmed the short-term local currency rating at 'A-2'. We also affirmed the long- and short-term South Africa national ratings at ‘zaAAA’ and 'zaA-1’.”
The ratings services said a prolonged strike in the platinum sector, as well as weak domestic and external demand, led GDP to contract in the first quarter of 2014 and is likely to depress second-quarter GDP growth.
The strike has led to a 25 per cent contraction in mining and quarrying output, and contributed to the overall economy contracting by 0.6 per cent of GDP in the first quarter of 2014. It will likely lead either to another contraction or to only-feeble growth in the second quarter as well as disappointing growth for the full year.
“We now expect full-year GDP growth of 1.9 per cent in 2014, rising to 2.9 per cent in 2015 and 3.2 per cent in 2016. This follows slow growth of 1.9 per cent in 2013 and 2.5 per cent in 2012, also partially due to prolonged strikes in the automotive sector in 2013 and the mining sector's wildcat strikes of 2012, and highlights a prolonged lackluster period for a country at this stage of development.”
While South Africa's fiscal outturn has held up so far, the fiscal stance over the next few years may become exposed to lower-than-expected economic growth, pressures from a new round of public-sector wage negotiations, and increased public spending needs. Although we expect the treasury to abide by its expenditure ceiling, slowing growth may reduce revenues and possibly place overall fiscal targets beyond reach.
General government debt, net of liquid assets, increased to 40 per cent of GDP in 2013, from 23 per cent in 2008, and we expect it to reach 46 per cent by 2017. Although little of the government's debt stock is denominated in foreign currency, non-residents hold 37 per cent of the government's rand-denominated debt.
The ratings are also constrained by sizable current account deficits. Although the rand floats and is an actively traded currency (according to the BIS triennial survey of foreign exchange dealing, it is traded in 1.1 per cent of global foreign-exchange contracts), the portfolio and other investment flows that finance these deficits can be volatile and can vary in price. Movements could come from global changes in risk appetite or from foreign investors reappraising prospective returns in the event of growth or policy slippage in South Africa. While capital inflows have resumed since February 2014--after a period of withdrawal--another reappraisal of risk is possible.
Slow growth and strikes may heighten both fiscal and external pressures.
Standard & Poor noted that the long-term local currency sovereign rating on South Africa is two notches above the long-term foreign currency sovereign rating.
This is because we believe that the sovereign's flexibility in its own currency is supported by the South African Reserve Bank's independent monetary policy and a large active local currency fixed-income market.
It said that the stable outlook reflects the agency’s view that current labour tensions will be resolved and that lackluster economic performance will not affect South Africa's fiscal and external balance beyond our revised expectations.
“We could lower the ratings if South Africa's business and investment climate weakens further, for instance if labour disputes fester. We could also lower the ratings if external imbalances continue to increase, or funding for South Africa's current account or fiscal deficits becomes more difficult or costly.”
The ratings services said that it could raise the ratings if an improvement in investment and economic growth prospects produces stronger government and external debt positions than we currently expect.