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London - Moody's Investors Service has today placed the Baa3 long-term issuer and senior unsecured bond ratings of the government of South Africa on review for downgrade.
The decision to place the rating on review for downgrade was prompted by a series of recent developments which suggest that South Africa's economic and fiscal challenges are more pronounced than Moody's had previously assumed. Growth prospects are weaker and material budgetary revenue shortfalls have emerged alongside increased spending pressures. Altogether, these promise a faster and larger rise in government debt-to-GDP than previously expected.
The review will allow the rating agency to assess the South African authorities' willingness and ability to respond to these rising pressures through growth-supportive fiscal adjustments that raise revenues and contain expenditures; structural economic reforms that ease domestic bottlenecks to growth; and improvements to SOE governance that contain contingent liabilities. The review period may not conclude until the size and the composition of the 2018 budget is known next February. This will also allow Moody's to assess the policy implications of political developments during the review period and the likelihood of pressures on South Africa's key policymaking institutions persisting.
In the meantime, South Africa maintains credit strengths that still support its Baa3 rating. These include deep domestic financial markets and a well-capitalized banking sector; a well-developed macroeconomic framework; and low foreign currency debt. Adherence to the Constitution and the rule of law continue to be the key pillars of strength of South Africa's institutions.
South Africa's (P)Baa3 Senior Unsecured Shelf and MTN program ratings were also placed under review for downgrade, as was the (P)P-3 Short-Term rating. In a related rating action, Moody's has also placed on review for downgrade the Baa3 backed senior unsecured rating of the ZAR Sovereign Capital Fund Propriety Limited.
South Africa's long-term local-currency bond and bank deposit country ceilings remain unchanged at A2. The long-term and short-term foreign currency bond ceilings remain unchanged at A3/P-2, respectively. The long- term foreign-currency bank deposits ceiling stays at Baa3, while the short-term foreign-currency bank deposits ceiling remains unchanged at P-3.
RATINGS RATIONALE
RATIONALE AND FOCUS OF THE REVIEW FOR DOWNGRADE
SLOWING GROWTH, REVENUE SHORTFALLS, RIGID WAGE BILL AND RISING BORROWING COSTS POSE CHALLENGES TO FISCAL CONSOLIDATION
The recently published Medium Term Budget Policy Statement (MTBPS) set out how the challenges facing the South African government in its efforts to contain the rise in public debt while enhancing medium term growth have risen since the rating action in June. Growth this year and next is forecast to be lower than was expected in June. While revenue growth outperformed nominal GDP growth between 2011 - 2015, revenues have materially undershot forecasts this year and are expected to continue to do so. At the same time, lower growth and rising poverty will magnify upward pressure on expenditures.
As a consequence, the country's government debt burden has increased by about one third since 2011, and will continue to rise due to relatively high deficits driven by revenue shortfalls, the government's rigid wage bill and rising borrowing costs. Unless a timely and effective policy response is implemented, debt-to-GDP will reach 60% by 2020/21 and continue to rise afterwards. That contrasts with Moody's earlier projections, from June 2017, that debt would reach about 55% of GDP in 2018/19 fiscal year and continue to rise but very gradually. Moody's has also lowered its growth forecast to 1.2% for 2018 and 1.7% for 2019 (from June projections of 1.5% in 2018 and 2.2% in 2019).
Several risks, if materialized, would lead to even faster debt accumulation than envisaged in the MTBPS. Those include risks stemming from the existence of high and concentrated contingent liabilities to creditors of state owned enterprises (SOEs), some of which are becoming increasingly reliant on public funding for sustaining their operations.
The MTBPS did not set out what measures would be taken to address the additional fiscal pressures. While we understand that the National Treasury has identified a set of revenue- and expenditure-based measures which would meet the funding gap in 2018/19 and 2019/20 fiscal years and limit the rise in debt somewhat, those measures have not been approved by the cabinet and will only be announced when the 2018 budget is published in February. So it remains unclear what assurance should be taken from the government's stated commitment to reduce the funding gap. Moody's also recognizes that fiscal consolidation will be increasingly challenging without revived growth.
The review will allow Moody's to assess the effectiveness of the government's policy response to these rising fiscal challenges, while mitigating the negative impact of fiscal consolidation on growth. It will also allow Moody's to assess further steps taken to improve the governance and stabilize the financial position of SOEs. The 2018 budget next February will be an important policy document, setting out the government's plan to respond to the country's economic and fiscal challenges. Unless other events bring greater clarity in advance of that date, the rating agency will likely conclude its review for downgrade in the month following the tabling of the 2018 budget.
GROWTH PROSPECTS REMAIN DIM IN AN UNCERTAIN POLITICAL ENVIRONMENT
Low growth lies at the heart of South Africa's fiscal problems. Growth has consistently underperformed expectations over recent years, undermining the government's efforts to meet its deficit targets. More recently, revenue shortfall in combination with rising poverty and unemployment, low growth has increased pressures on expenditures. In the current political environment, that pattern shows little sign of ending, and has been amplified by questions about the capacity of the South Africa's Revenue Service (SARS) to collect revenues effectively.
Near-term growth prospects remain constrained by low investor confidence. Rising uncertainty over near- and medium-term policy priorities has brought investor confidence to the lowest level since 2009. Investment fell by 3.9% in 2016 and continued to decline through 2017. Investment levels are likely to remain low until a more stable and investment friendly policy environment emerges.
Low investment will limit South Africa's growth over the medium-term. Potential growth also continues to be constrained by halting progress on structural reforms, including on the structure and regulation of the mining sector, on the governance of SOEs, and on plans to reform the educational system to close the persistent skill gap.
Both low investor confidence and limited progress on structural reforms are rooted in the uncertainty created by the fluid and unpredictable political environment. That environment is reflected in the current lack of clarity over the government's fiscal plans. Unclear and shifting policy objectives, political maneuvering and frequent changes of leadership in key ministries, and concerns over the pressures on the key policymaking institutions such as the Reserve Bank and the National Treasury, have weakened South Africa's economy, finances and institutions.
Events during the review period may offer some clarity regarding the future path of South Africa's political economy, and therefore regarding the prospects for investment and for the structural reform effort and ultimately for growth. Political developments may provide insights into the direction, content and credibility of the future policy framework. The review period will therefore also allow Moody's to take stock of the implications of political developments for key structural reforms that could boost investor confidence in the near term and support higher growth trends over the medium- and longer-term.
RATIONALE FOR THE Baa3 RATING
South Africa's credit profile retains a number of features that support a Baa3 rating. Its economy is large and well-diversified, though characterized by low growth and high unemployment. Its domestic financial markets are deep and its banking sector is well-capitalized. It possesses a well-developed macroeconomic framework. While debt levels have risen, at current levels they remain consistent with Baa3 peers. And though reliance on external capital creates exposure to shocks, the flexible exchange rate and low foreign currency debt serve as buffers. Despite recent encroachments, its core institutions remain independent and strong, with a well- functioning civil society. Adherence to the constitution and the rule of law continue to be the key pillars of South Africa's institutional strength.
WHAT COULD CHANGE THE RATING - DOWN
Moody's would downgrade the rating if the review were to conclude that South Africa's economic, institutional and fiscal strength will continue to weaken. A downgrade would likely result were the rating agency to conclude that measures to address funding gaps over the next two years lacked credibility or that the lack of progress with structural reforms effort would result in an environment not conducive to investment and growth. Lack of structural reforms would also send a negative signal regarding the strength of South Africa's institutions, in particular about government effectiveness in enacting sound policies. Relatedly, any developments which cast further doubt over the independence and credibility of core institutions including the National Treasury and the Reserve Bank would be strongly credit negative.
WHAT COULD LEAD TO CONFIRMATION OF THE RATING AT THE CURRENT LEVEL
Moody's would confirm the rating at Baa3 if the review were to conclude that the policy response is likely to bring the economic, institutional and fiscal trends on a path so that these factors remain consistent with Baa3 peers; and that developments in the political economy offer the prospect of a more stable, growth-friendly institutional backdrop.
- GDP per capita (PPP basis, US$): 13,291 (2016 Actual) (also known as Per Capita Income) Real GDP growth (% change): 0.3% (2016 Actual) (also known as GDP Growth)
- Inflation Rate (CPI, % change Dec/Dec): 7.1% (2016 Actual)
- Gen. Gov. Financial Balance/GDP: -3.3% (2016 Actual) (also known as Fiscal Balance) Current Account Balance/GDP: -3.3% (2016 Actual) (also known as External Balance) External debt/GDP: 48.4% (2016 Actual)
- Level of economic development: Moderate level of economic resilience
- Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 21 November 2017, a rating committee was called to discuss the rating of Government of South Africa. The main points raised during the discussion were: The issuer's institutional strength/framework, has decreased.
The issuer's fiscal or financial strength, including its debt profile, has decreased.
