South Africa looks to structural reforms as it loses its last investment-grade credit rating

By: Elliot Smith

KEY POINTS

  • South Africa now has no investment-grade sovereign credit rating from any of the major ratings agencies for the first time since its return to global markets in 1994.
  • Moody’s announced on Friday that it had cut the country’s last investment-grade rating to “junk,” sending the Rand to an all-time low of below 18 to the dollar.
  • Finance Minister Tito Mboweni has announced the creation of a unit within the finance ministry to focus on structural reform in a bid to fundamentally reshape the South African economy.

South Africa has lost its last remaining major investment-grade sovereign credit rating, as existing economic weakness is compounded by the potential impact of the global coronavirus pandemic.

South Africa has no investment-grade sovereign credit rating from any of the major ratings agencies for the first time since its return to global markets in 1994.

Moody’s announced on Friday that it had cut the country’s last investment-grade rating to “junk,” sending the Rand to an all-time low of below 18 to the dollar. Standard & Poors and Fitch both downgraded Africa’s most industrialized economy to sub-investment grade in 2017.

In its release, Moody’s cited structurally weak growth, limited capacity to stimulate the economy and an “inexorable rise” in government debt over the medium term as key reasons for the downgrade and maintenance of its “negative” outlook.

The situation has been exacerbated by the expected economic impact of the coronavirus pandemic. Confirmed cases in South Africa have now exceeded 1,300, though the government is hoping that drastic early lockdown measures will prevent the exponential spread seen in Europe and the U.S.

“Unreliable electricity supply, persistent weak business confidence and investment as well as long-standing structural labour market rigidities continue to constrain South Africa’s economic growth,” Moody’s said, adding that these factors mean South Africa is entering a period of much lower global growth in an “economically vulnerable position.”

Debt-to-GDP (gross domestic product) increased by 10 percentage points from 2014-18 and Moody’s expects this to rise by a further 22 percentage points between 2019 and 2023, with the deficit widening in 2020 to around 8.5% of GDP.

Fiscal strains from interest payments and support to state-owned enterprises will continue, the agency predicted. The government debt burden is expected to rise from 69% of GDP in 2019 to 91% by the end of 2023.

‘It is up to South Africa’

“South Africa’s credit rating has deteriorated because of very low (and currently negative) economic growth, large fiscal deficits and sharply rising public debt, loss-making state-owned entities, and deep contestation of proposed social and economic policy reforms,” explained Jeff Gable, head of research at South Africa’s Absa Bank.

In a statement Monday, Gable suggested that whether South Africa will return to investment grade or slide further away relies on the country demonstrating “significant improvement” in its economic reforms.

“It is hard to argue that South Africa hasn’t witnessed a steep deterioration in fundamentals, in part by our own inability to act over the last decade and in part due to the new risks due to the global virus,” Gable said.

“And so it is the agencies’ duty to reflect that in their ratings. Similarly it is clear that it is up to South Africa, and not the credit rating agencies, as to which direction that country would like to take going forward.”

Bold structural reforms

On Sunday, Finance Minister Tito Mboweni and South African Reserve Bank (SARB) Governor Lesetja Kganyago held a media conference call, in which Mboweni said that he and President Cyril Ramaphosa had vowed to move “more boldly” on their structural reforms program.

Mboweni announced the creation of a unit within the finance ministry called “Vulindlela” – which means “lead the way” in isiZulu – that “will become the front soldiers of structural reforms in the South African economy,” according to a research note Monday from NKC African Economics.

GP: Pre-WEF breakfast briefing ahead of Davos 181011 Asia 
President Cyril Ramaphosa during a pre-World Economic Forum breakfast briefing on January 18, 2018 in Johannesburg, South Africa. Moeletsi Mabe| Sunday Times | Gallo Images | Getty Images

The finance minister also suggested in an interview with newspaper City Press over the weekend that the World Bank, and not the IMF (International Monetary Fund), would be the first port of call for loan financing.

“The World Bank, unlike the IMF, does not typically attach conditions to its loans. This is why it will be a more politically palatable action for the government in South Africa, where public opinion is generally suspicious of the IMF and the effects its policy prescriptions have had in poor countries,” NKC Senior Political Economist Francois Conradie said Monday.

However, Conradie suggested that the types of reforms which will address the issues that led to Moody’s downgrade, such as deep cuts to the public sector wage bill, privatizing state-owned enterprises (SOEs), or relaxing strict labor legislation, will be a hard political sell.

“Government has been good, in recent weeks, in communicating its response to the pandemic by explaining how the lockdown works, but now it will have to be clear in communicating its economic policy response as well,” he added.

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