SA is in sticky situation with deep consequences - economist

Cape Town – Moody’s Investor Services is likely to downgrade South Africa’s sovereign credit rating with one notch to a level just above junk status in the next review period, said Peter Attard Montalto, emerging market economist from Japanese bank Nomura, in a company note. 

Last week, Standard & Poor’s (S&P) Global Ratings and Fitch Ratings both cut South Africa’s credit rating to sub-investment grade which leaves Moody’s as the “laggard”. 

READ: Downgrade: Where to now?

“[Moody’s] ratings framework seems far too optimistic – it seems overly reliant on very much lagging quantitative institutional quality indices as well as the circular argument that it will watch portfolio flows before making a decision.” 

Montalto opines Moody’s is likely to cut South Africa’s foreign currency and local currency ratings to be on the cusp of sub-investment grade – most likely in the period between May 5 and July 3. A further downgrade to junk could take place after the medium-term budget policy statement that usually takes place towards the end of October. 

In addition, Nomura believes S&P could downgrade South Africa’s local currency, which is currently at BBB- (the lowest investment grade), to junk status.  Fitch on Friday downgraded both the foreign and local currency rating to junk status.

READ: FULL STATEMENT: Fitch explains SA downgrade

South Africa lost inclusion in the JP Morgan investment-grade emerging market bond index as a result of the downgrades from S&P and Fitch last week, which may be followed by an exclusion from the World Government Bond Index (WGBI) if Moody’s also downgrade South Africa to sub-investment grade. 

“This would amount to outflows of $6bn to $7bn,” says Montalto. Nomura estimates that passive-rating sensitive investments in South African government bonds are around $10bn, which is about 9% of the debt stock out of an estimated 38% of foreign ownership of local debt. 

'A sticky situation with deep consequences' 

Montalto is of the view that people, in the wake of President Jacob Zuma’s Cabinet reshuffle and the subsequent credit ratings downgrades, are either too hyperbolic (saying SA is following the same path as that of Zimbabwe) or too optimistic (believing Deputy President Cyril Ramaphosa would take over as president of the country.

“As we see it, the reality is worrying, but more subtle and drawn out,” he says. The markets – and ratings agencies to a lesser degree – are still making up their minds about the path South Africa is on. 

“One thing is certain – this is not a ‘normal’ sentiment shock, or a brief negative that will be reversed shortly as with Nene-gate (when Zuma was compelled to replace Des van Rooyen with the experienced Pravin Gordhan as finance minister).

“This is a sticky situation with deep consequences.”

Key things to remember

“There is a serious and considered strategy being undertaken by the President who is a master at playing the ANC at its own collectivist game,” Montalto points out. He also believes events in the country will extend beyond National Treasury and involve the judiciary, Parliament, the security services and state-owned enterprises. 

Zuma’s strategy over the long term extends from the ANC’s elective conference in December at which Nkosazana Dlamini-Zuma, former AU President, will take over as the new party leader. 

READ: ANC leader race down to Dlamini-Zuma and Ramaphosa - Bloomberg survey

Montalto is of the view that Dlamini Zuma could take over as president of the country in May next year “to allow her momentum to go on to win the 2019 elections”. 

Long-term outlook 

“On the positive side,” Montalto says, “the ANC could simply wither if internal divisions affect its ability to fight the 2019 elections”. 

However, it’s unclear what will happen if the ANC drops below 50% in 2019, given the constraints and policy contradictions of opposition parties. 

The most positive long-run scenario would be a transition to a high-growth reform plan that balances the needs of transformation and historical redress without hampering job creation. 

“Such a path does not seem to be on offer in South Africa from any political party at present,” Montalto said. 

READ: Alternative agendas threaten ANC leadership race

On the negative side, however, a stranglehold on the ANC by the Zuma faction could “infect” the government with more authoritarian tendencies after the elective conference, which could include “ignoring” the courts and a more radical implementation of a transformation agenda that ignores property rights and the Constitution. 

In such a negative scenario, violence could increase around repeated protest action against a Zuma presidency where structures such as the ANC Youth League and the MK Veterans could become more militant. 

Montalto stresses though that “the long run” may very well arrive quicker in South Africa. “So much is up in the air now and there could be deeper changes of view within the political and economic debate in South Africa. This could be the route to better long-run growth.”