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Cape Town – Moody’s decision to downgrade South Africa’s sovereign credit rating from Baa2 to Baa3 with a negative outlook hinged on a weakened institutional framework, reduced growth prospects, which limits the pace of structural reforms and an erosion of fiscal strength.
Zuzana Brixiova, Moody’s lead sovereign analyst for South Africa, answers a number of questions about South Africa's strengths and weakness that could change its credit rating in future.
Q: Has Moody's view on the strength of SA’s institutions changed over the last few years?
South Africa’s institutional framework has weakened progressively over several years, but the deterioration has become more apparent in recent months with infighting in the run up to ANC elections in 2017 that culminated with the March Cabinet reshuffle.
The reshuffle illustrates a gradual erosion of institutional strength. The institutional framework has become less transparent, effective and predictable, and policymakers’ commitment to reforms less clear.
READ: Treasury warns of more credit ratings shocks as Moody's downgrades SA
The institutional weakening has manifested itself in systemic corruption, which has been widely discussed in South Africa's public debate.
In addition, there has been excessive reliance on the court system, which means South Africa runs the risk of so-called judicial overreach where the judicial branch of the government is often approached to compensate for the gaps in functioning of the other government branches.
However, the strength of key institutions such as the judiciary, the South African Reserve Bank (SARB) and the National Treasury count in the country’s favour.
Adherence to the Constitution‚ accountability and the rule of law are pillars of South Africa’s institutional strength and a number of key institutions, such as the courts, the Auditor-General and the SARB have remained independent and fulfilled their mandates. A free and vibrant press, universities, and NGOs also help uphold transparency and accountability.
Q: How rapidly will SA’s economy grow?
South Africa has been caught in a low growth trap since the global financial crisis in 2009. The private sector's incentives to invest are limited by continued political and policy uncertainty, mixed progress on structural reform, and skill shortages because of the education system.
Investment in the mining industry has also deteriorated due to regulatory uncertainty (the delay in implementation of the Mineral and Petroleum Resource Development Act and Mining Charter). On the positive side though commodity prices have recovered moderately and electricity production has increased.
The agricultural sector has also recovered after a severe drought over the last two years.
READ: SA enters recession as GDP contracts for a consecutive quarter
The March Cabinet reshuffle though is likely to have a negative impact on investor confidence as it amplifies uncertainty. In particular, rhetoric about radical economic transformation and land reform are a concern to investors.
The trust and cooperation that have been built up between labour, business and government have suffered a setback following the Cabinet reshuffle and as a result the private sector have taken a “wait and see” stance to investment.
As a result of these factors, Moody’s adjusted its growth prospects for South Africa downwards – from 1.1% in 2017 to 0.8% and from 1.7% in 2018 to 1.5%.
Although Moody’s expect South Africa to benefit from a gradual global recovery and some rebound in commodity prices, its growth has somewhat decoupled from those of other advanced economies since the global financial crisis, which shows there are domestic structural bottlenecks, as is evident in the limited reform of state-owned enterprises, rigidity in the budget, and an educational system that does not equip graduates with the skills demanded in the labour market, among other things.
Q: What is the outlook for South Africa's debt?
The South Africa government foresees a primary surplus, while stabilising the debt to GDP ratio by 2018/19.
Although the 2017 Budget forecast that debt to GDP will peak at 53% of GDP and then decline, the ratio has more than doubled between 2009 and 2016.
READ: Budget: Gigaba seeks to narrow deficit
Moody’s expects National Treasury – even under the new leadership of Finance Minister Malusi Gigaba – to adhere to the expenditure ceilings previously set out. But there are risks, such as public wage demands (the current three-year agreement ends in 2018). Coupled with this are weaker than expected GDP growth and lower revenue collection than projected, especially in light of the underperformance of revenue collection in 2016.
The ratings agency therefore foresees that the debt-to-GDP ratio will continue to rise to 55% in 2018/19. This ratio is far below the 70% of GDP which the International Monetary Fund (IMF) considers to be a high debt risk threshold in its July 2016-country report on South Africa.
However, the debt is highly concentrated in a few state entities, which could see a jump in the debt ratio. In its debt sustainability assessment of South Africa, the IMF says a combination of growth, revenue, interest rates and currency disruption could see South Africa’s debt ratio increase to around 65% of GDP.
The fact that South Africa’s debt has a low share of foreign-currency denominated debt provides a buffer against exchange rate risk.
READ: SA's debt to GDP highest among emerging market peers - report
Q: What underpins South Africa’s credit-rating?
There are a number of factors that count in South Africa’s favour that Moody’s sees as “credit strengths”. These include:
- deep and well-developed domestic financial markets and a well-capitalised banking sector;
- a coherent macroeconomic framework;
- low levels of foreign-currency debt; and
- the independence and effectiveness of key institutions (the courts, SARB and auditor-general).
READ: SA economy its own worst enemy - analysts
Moody’s also sees National Treasury’s collaboration with the World Bank to continuously improve its debt management in line with global best practices as positive. This includes keeping short-term debt maturing in 12 months as a share of total domestic debt equivalent to or below 15%, and keeping foreign debt as a share of total government debt equivalent to or below 15%.
Together with liquid domestic capital markets, these improvements reduce the sovereign's refinancing risks, and allow South Africa to have a somewhat higher debt burden.
Compared to Turkey, which has a Ba1-rating with a negative outlook (sub-investment grade), South Africa’s Baa3-rating (one notch above sub-investment grade) is appropriate, as the country has stronger institutions.
South Africa’s economic and fiscal strengths are somewhat lower than Turkey, but the key difference between the two countries is that South Africa is not as vulnerable to sudden risks, such as political or an abrupt halt in capital flows.
Q: What are the main risks to South Africa’s credit rating?
Moody’s sees the possibility of attempts to capture state institutions as a significant risk to South Africa’s investment grade rating. This could intensify in the run-up to the ANC’s elective conference in December 2017 and even the 2019 general election.
State capture attempts will lead to more policy uncertainty and dilute reforms, which in turn will weigh even heavier on already low investor confidence.
Under such a scenario, institutions could become weaker and economic growth and the debt-to-GDP ratio could deteriorate further.
South Africa’s investment-grade rating will depend on government’s success in protecting South Africa’s institutions, economy and fiscal strength. If not, it could lead to further credit rating downgrades.
READ: How SA can get back to investment grade
On the other hand, Moody’s could change the credit rating outlook from negative to stable if government delivers on the following commitments:
- guarantee the continued independence and strong policy-making capabilities of institutions;
- bring about medium-term economic growth;
- stabilise the debt burden; and
- decrease the value of guarantees to state-owned entities.
