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Political infighting within the ANC has been flagged as the major reason why South Africa’s credit rating is on the brink of falling to “junk”.
he two ratings agencies which delivered updates over the weekend, Fitch and Moody’s, both marked politics as their primary concern, arguing that without cohesion there is little chance of urgent economic reforms.
As you might expect, National Treasury has put a positive spin on the reports, but independent economist Azar Jammine of Econometrix is not convinced.
In this deeply thoughtful analysis he warns that the SA political situation remains extremely fluid with the potential to cause enormous damage. Even more so after the fresh challenge to President Jacob Zuma from within the ANC.
He disagrees with Finance Minister Pravin Gordhan’s upbeat response, and is convinced that as things stand, the country remains on the destructive path to a credit downgrade. – Alec Hogg
By Azar Jammine*
On Friday afternoon we reported on the disappointing, although not unexpected, decision on the part of Fitch credit rating agency to revise the outlook on South Africa’s foreign debt to “negative” from “stable” previously.
With Fitch’s rating just one notch above the threshold which distinguishes between investment grade and speculative or junk grade, we interpreted this move as being ominous, highlighting a significantly increased probability that Fitch may well move South Africa’s credit rating to junk status in six months’ time when it reviews the credit rating again.
In light of this, one was slightly appeased a few hours later when Moody’s credit rating agency refrained from altering its credit rating on South Africa from being two notches above the junk status threshold, but with a “negative” outlook remaining.
This position is not as ominous as that of Fitch, because even though Moody’s might downgrade South Africa’s credit rating on its next review, this would merely take such credit rating to one notch above junk status and leave it in investment grade territory.
This is important, because many key emerging market bond indices which include South Africa’s debt as a component, are not allowed to drop the country from such indices unless all three main credit rating agencies were to downgrade to junk.
Given Moody’s decision, this is unlikely to occur within the next six months and so the worst-case scenario, which risks generating a major sell-off in South African government bonds, has been averted for the short term at least.
Of course, there could still be important bad news on Friday this week when S&P Global Ratings issue their decision on the country’s credit rating. Given that S&P already has the country’s rating at just one notch above junk status but also has a “negative” outlook, there is a significant chance that the agency might well downgrade South Africa’s credit rating to junk status in a week’s time.
But in light of the fact that such a downgrade would be an isolated one, not shared by the other two main rating agencies, the possible damage of such a ratings downgrade to junk might not be seen as devastating yet at this stage.
Moody’s provides similar warnings as Fitch about need for structural reform and political stability
Following the fairly thorough analysis by Fitch of why it decided on the downward revision of the credit rating outlook, there does not appear to have been any additional major insight presented by Moody’s over and above what Fitch presented.
Fitch argued that political infighting within the ruling party was contributing towards distracting attention away from structural reforms needed to improve the country’s economic growth. In turn, higher economic growth was needed in order to reduce budget deficits as a means of containing the rising trend of the public debt to GDP ratio.
Furthermore, political turmoil was also contributing towards preventing appropriate governance and management of SOEs, raising the risk that they would be obliged to rely on government funding unless the situation was improved. As a result, government debt was bound to increase on these grounds as well.
Moody’s cited political turmoil as an impediment to improving the situation, but did not go into the same detail as Fitch. Nonetheless, in similar vein to Fitch, Moody’s commended Treasury on its oversight of keeping expenditure reasonably under control.
It did, however, in the same way as with Fitch, warn that unless appropriate structural reforms were instituted, the “negative” outlook on its credit rating would transform into a full-scale downgrade to a lower notch.
Finance Ministry contests view that politics is interfering with economic reforms
There can be no doubt that the concerted effort made by the Ministry of Finance to engage with leading businessmen and certain trade union leaders to develop some initiatives to try and improve economic growth has been well received by the ratings agencies.
Azar Jammine, chief economist, Econometrix
We suspect that at the margin these efforts did indeed succeed in staving off a credit rating downgrade. This has led the Minister of Finance Pravin Gordhan to express satisfaction that the combined efforts of different parties had assisted in enabling South Africa to avoid the downgrade path experienced by other countries.
Even so, we would contend that, notwithstanding signs of a gradual turnaround in the declining fortunes of South Africa’s economic growth over the past five years, the escalation of political instability in South Africa over the past two years has indeed contributed towards reducing business confidence and in this way contributing towards lower economic growth.
This is reflected by the cumulative -29% decline in the level of capital formation by the private sector since the end of 2014.
What is particularly worrisome about this is that capital formation is required to assist in generating improved economic growth in the longer term. Therefore, declining fixed investment is bound to impair the country’s ability to raise that economic growth rate and in so doing is bound to jeopardise chances of averting a downgrade to junk status next time round.
There is only so much that perceptions of cohesion towards structural reforms aimed at improving economic growth can outweigh the reality of continuing suboptimal growth in the medium to longer term.
Real structural reforms still far in the making
So-called “Team South Africa”, consisting of government officials, 80 CEOs and trade union officials working together and touring the world to woo investors and persuade them that concerted efforts are being made to restructure the South African economy as a means of improving economic growth and raising tax revenues, has come out with a number of proposals.
These include the development of an internship scheme to enable school leavers and university graduates to gain access to their first job through a subsidised process that would encourage businesses to take on such interns. Furthermore, a R1.5bn fund has been planned to assist in the establishment of small businesses. Thirdly, a Commission of Inquiry into the advisability of introducing a national minimum wage released a report last week recommending that such a wage be introduced at R3500 per month.
Also read: Nedlac’s R3 500 miniimum wage – too low a starting point?
The reality, however, is that many of these schemes are being opposed by trade unions.
The internship scheme is perceived to threaten the jobs of trade union members who are already employed. In the case of the national minimum wage, unions have already expressed their dismay at the low level at which the proposed minimum wage has been set. With regard to the fund to assist small businesses, it is actually tiny in relation to a national budget of R1.4trn.
There still appears to be a yawning gap between the market-oriented solutions sought by the business sector and the socialist-interventionist solutions sought by the working class.
Education and skills development outcomes leave much to be desired. Tensions between employers and workers are still amongst the worst in the world. It also remains to be seen whether CEOs of big businesses are prepared to forego some of their high levels of remuneration as a sop to the workers to improve industrial relations in the midst of accusations of high levels of inequality generated by an exploitative “(mainly) white capitalist structure”.
South Africa’s finance minister Pravin Gordhan. Photographer: Waldo Swiegers/Bloomberg
Is one likely to see sufficient progress in breaking down the concentration of power in the hands of big business and SOEs in favour of the creation of labour absorptive small businesses through the kind of initiative proposed? Is there the will on the part of big businesses to open up to competition from small businesses?
The issue of land reform is a further perceived structural impediment to higher economic growth and productivity and is also highly emotive. These are fundamental issues that need to be addressed in order to ensure a sustained and meaningful improvement in the level of economic growth is sufficient to ensure the absorption of the armies of unemployed persons and new entrants into the labour force.
Can fluid political situation calm down?
Finally, can one really look forward to a more benign political environment over the next year or two that might help to improve business confidence and through this economic growth?
Developments over the past weekend in which the National Executive Council (NEC) of the ANC is debating whether or not to recall President Zuma might be seen as a positive development in the direction of improved political stability.
It is an unprecedented development given that the major support base for Zuma in the past has been drawn from the NEC.
It has frequently been argued that even though there has been significant dissatisfaction within the ruling ANC and its Alliance partners with Zuma’s leadership, the fact that a majority in the NEC has supported the president has stymied attempts at removing him and avoiding further damage to the economy.
Moodys didn't have to downgrade us. Boks did it all by themselves.
— Michael Jordaan (@MichaelJordaan) November 26, 2016
In light of the NEC’s deliberations over a possible recall of President Zuma, the domestic political situation is therefore very fluid.
However, one should not underestimate the president’s determination to see out his term of office as leader of the country let alone leader of the party. He has it within his power to undertake a Cabinet reshuffle which could delay his removal.
In particular, there would be concerns that he might use the opportunity to replace Pravin Gordhan and/or Deputy Finance Minister Mcebisi Jonas, who split on the offer made to him by the Gupta family to become Finance Minister, presumably under Zuma’s stewardship.
There is therefore much water under the bridge still to cover in the run-up to the ANC’s party presidential election in a year’s time.
It would seem naive to support Gordhan’s view that the resultant infighting within the party will not prove a distraction to undertaking the kind of structural reforms needed to persuade the ratings agencies from translating their “negative” outlook’s into full-scale downgrades.
In the case of S&P Global Ratings, they may not wish to wait any longer in downgrading the country’s credit rating when their turn to make an announcement next Friday comes.
- Azar Jammine is the chief economist at Econometrix
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