Moody’s Investors Service has today placed the Baa2 long-term issuer and senior unsecured bond ratings of the government of South Africa on review for downgrade.
The decision to initiate a review for downgrade was prompted by the abrupt change in leadership of key government institutions. That action has raised questions regarding:
– progress on reforms previously identified as essential to sustain South Africa’s fiscal and economic strength, and the effectiveness of South Africa’s policymaking institutions; and
– the more immediate implications for growth and public debt given the potentially negative impact on fragile domestic and external investor confidence.
The review will allow Moody’s to assess these risks and if the changes in leadership signal a weakening in the country’s institutional, economic and fiscal strength.
South Africa’s (P)Baa2 Senior Unsecured Shelf and MTN program ratings were also placed under review for downgrade, as was the (P)P-2 Senior Unsecured Short-Term rating.
In a related rating action, Moody’s has also placed on review for downgrade the Baa2 senior unsecured rating of the ZAR Sovereign Capital Fund Propriety Limited, which is fully and unconditionally guaranteed by the Republic of South Africa.
South Africa’s long-term local-currency bond and bank deposit country ceiling remain unchanged at A1. The long-term foreign-currency bond and bank deposits country ceilings remain unchanged at A2 and Baa2, respectively.
Its short-term foreign-currency bonds and bank deposits country ceilings also remain unchanged at Prime-1 (P-1) and Prime-2 (P-2), respectively.
On 30 March, the President of South Africa announced wide-ranging changes to the country’s government, changing top leadership in 10 ministries, including in key portfolios such as finance and energy.
Changes within a government do not generally signal material changes in a country’s credit profile. Here, however, the timing and scope of the reshuffle raises questions over the signal they send regarding the prospects for ongoing reforms, the underlying strength of South Africa’s institutional framework, and the fragile recovery in the country’s economic and fiscal position.
POLICYMAKING, ECONOMIC AND FISCAL REFORM
The review will assess the likelihood of changes in key areas of financial and macro-economic policymaking as well as in strategic structural areas such as energy policy. In recent years, a number of important areas for reform have been identified by the government, aimed at boosting potential growth and consolidating public finances, including those of state-owned enterprises (SOEs), in order to enhance the sustainability of government finances, and contain exposure to contingent liabilities.
Some key reforms have indeed been implemented, with commensurate improvements in areas such as energy provision and industrial relations.
However, several aspects of the government’s reform programme remain outstanding, particularly in completing the legislative and administrative framework governing the mining sector, product market competition, in the labour market, in relation to the development of the private sector, and in encouraging a more even distribution of wealth.
During the review, Moody’s will assess any announced or likely changes in the government’s plans and the implications for potential growth and hence for the reversal of the rising debt burden. Moody’s will also assess any implications for progress on currently stalled structural reforms in strategic areas such as regulation of the mining sector or regulations that would increase transparency in the financial transactions of large businesses; and the prospects for continued progress on reforms to enhance transparency, accountability and good governance in the SOE sector, and to remove structures that encourage rent-seeking over achievement of public policy goals.
The review will also explore the implications of the underlying political dynamics which led to the changes in ministerial appointments for the predictability of South Africa’s institutional framework, including for the government’s capacity to conduct sound economic policies which foster economic and fiscal strength. The strength of South Africa’s institutions has been historically an important source of support to the creditworthiness of the country, nurturing a policy framework that has generally been effective in containing fiscal and macroeconomic imbalances. Moody’s intends to use the review to determine whether the ongoing tensions within the ANC weaken the credibility and effectiveness of South Africa’s policymaking, the effectiveness and independence of the public service and ultimately the strength of the country’s institutions.
IMPLICATIONS FOR GROWTH AND DEBT SUSTAINABILITY
South Africa’s economy appears to be turning a corner. After years of Moody’s, in common with other commentators, adjusting growth forecasts downwards, a combination of factors resulted in a growth outturn for 2016 which, while very low (+0.3%), was consistent with prior forecasts.
Moody’s expectations were a recovery in growth to just over 1% in 2017 and close to 2% in 2018. Fiscal consolidation, including stabilizing the debt-to-GDP ratio, was similarly on track.
That recovery reflects a number of factors. Some include the reforms mentioned earlier, which have restored stability into electricity supply and reduced industrial disputes. Others include the gradual recovery in world growth and trade, the stabilization of commodities prices and the easing of drought conditions.
But the recovery is fragile, and higher growth in future will be highly dependent on domestic and external investment, and therefore on investor confidence. Although South Africa has low foreign currency-denominated debt, about one third of government’s rand-denominated bonds is held by non-residents, implying higher yields and rollover risk exposure should investor confidence be undermined. Moreover, rising business confidence is a precondition for the revival of private investment, which declined last year and Moody’s projects it to stagnate in 2017.
Moody’s review will seek to clarify to what extent these indicators and broader sentiment within the business community may be impacted by the reshuffle. The review period will allow Moody’s to gain a better picture of any potential changes to medium term fiscal plans, the impact on market prices, inflationary pressures and renewed liquidity challenges of SOEs.
WHAT COULD CHANGE THE RATING – DOWN
Moody’s could downgrade South Africa’s issuer rating if the rating agency were to conclude that recent events signaled a deterioration in the effectiveness of government or in the credibility of its policy-making; and relatedly in the country’s economic or fiscal strength. Such a conclusion would be supported by, for example, i) a shift towards policies that Moody’s concluded were likely to undermine economic and/or fiscal strength; for example a likely deviation from measures outlined in the 2017 budget and the related medium term framework or the lack of progress on SOE reform; or ii) further domestic or external shocks to growth.
WHAT COULD LEAD TO CONFIRMATION OF THE RATING AT THE CURRENT LEVEL
Moody’s would confirm the rating at Baa2 if the review were to conclude that the impact of recent events on government fiscal and economic policies and on the economy’s forecast and potential growth was likely to be minimal.
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