FULL STATEMENT: S&P cuts SA to junk status, fears political risks | Fin24
 
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FULL STATEMENT: S&P cuts SA to junk status, fears political risks

Apr 03 2017 18:19

S&P has downgraded South Africa to junk status, noting that President Zuma has put at risk South Africa's fiscal and growth outcomes with his Cabinet changes.

Overview:

• In our opinion, the executive changes initiated by President Zuma have put at risk fiscal and growth outcomes.
• We assess that contingent liabilities to the state are rising.
• We are therefore lowering our long-term foreign currency sovereign credit rating on the Republic of South Africa to 'BB+' from 'BBB-' and the long-term local currency rating to 'BBB-' from 'BBB'.
• The negative outlook reflects our view that political risks will remain elevated this year, and that policy shifts are likely, which could undermine fiscal and economic growth outcomes more than we currently project.

Rating action

On April 3, 2017, S&P Global Ratings lowered the long-term foreign currency sovereign credit rating on the Republic of South Africa to 'BB+' from 'BBB-' and the long-term local currency rating to 'BBB-' from 'BBB'.

We also lowered the short-term foreign currency rating to 'B' from 'A-3' and the short-term local currency rating to 'A-3' from 'A-2'. The outlook on all the long-term ratings is negative.

In addition, we lowered the long-term South Africa national scale rating to 'zaAA-' from 'zaAAA'. We affirmed the short-term national scale rating at 'zaA-1'.

As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the Republic of South Africa are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar Of 2017 EMEA Sovereign, Regional, And Local Government Rating Publication Dates," published Dec. 16, 2016, on RatingsDirect). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation.

In this case, the reasons for the deviation are the heightened political and institutional uncertainties that have arisen from the recent changes in executive leadership. The next scheduled rating publication on the sovereign rating on the Republic of South Africa will be on June 2, 2017.

Rationale

The downgrade reflects our view that the divisions in the ANC-led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk. This has increased the likelihood that economic growth and fiscal outcomes could suffer. The rating action also reflects our view that contingent liabilities to the state, particularly in the energy sector, are on the rise, and that previous plans to improve the underlying financial position of Eskom may not be implemented in a comprehensive and timely manner. In our view, higher risks of budgetary slippage will also put upward pressure on South Africa's cost of capital, further dampening already-modest growth.

Internal government and party divisions could, we believe, delay fiscal and structural reforms, and potentially erode the trust that had been established between business leaders and labor representatives (including in the critical mining sector). An additional risk is that businesses may now choose to withhold investment decisions that would otherwise have supported economic growth. We think that ongoing tensions and the potential for further event risk could weigh on investor confidence and exchange rates, and potentially drive increases in real interest rates.

We have also reassessed South Africa's contingent liabilities. This reflects the increased risk that nonfinancial public enterprises will need further extraordinary government support. We expect guarantee utilizations will reach R500bn in 2020, or 10% of 2017 GDP. The utilizations are dominated mainly by Eskom (BB-/Negative/--), which benefits from a government guarantee framework of R350bn (US$25bn) about 7% of 2017 GDP. We estimate Eskom will have used up to ZAR300 billion of this framework by 2020.

South Africa's energy regulator has capped Eskom's permitted 2017/2018 tariff increase at 2.2% - with negative implications for its financial performance. Eskom will fund the resulting revenue gap via borrowings of up to R70bn, of which up to half may utilize government guarantees. Other state-owned entities that we think still pose a risk to the country's fiscal outlook include national road agency Sanral (not rated), which is reported to have revenue collection challenges with its Gauteng tolling system, and South African Airways (not rated), which may be unable to obtain financing without additional government support. While governance reforms have proceeded at the airline, Eskom still has to complete its board appointments and appoint a permanent CEO. Broader reforms to state-owned enterprises are still being discussed and we do not foresee implementation in the near term.

South Africa continues to depend on resident and nonresident purchases of rand-denominated local currency debt to finance its fiscal and external deficits. We estimate that the change in general government debt will average 4.2% of GDP over 2017-2020. On a stock basis, general government debt net of liquid assets increased to about 48% of GDP in 2017 from about 30% in 2010, and we expect it will stabilize at just below 50% of GDP in the next three years. Although less than one-tenth of the government's debt stock is denominated in foreign currency, nonresidents hold about 35% of the government's rand-denominated debt, which could make financing costs vulnerable to foreign investor sentiment, exchange rate fluctuations, and rises in developed market interest rates. We project interest expense will remain at about 11% of government revenues this year.

South Africa's pace of economic growth remains a ratings weakness. It continues to be negative on a per capita GDP basis. While the government has identified important reforms and supply bottlenecks in South Africa's highly concentrated economy, delivery has been piecemeal in our opinion. The country's longstanding skills shortage and adverse terms of trade also explain poor growth outcomes, as does the corporate sector's current preference to delay private investment, despite high margins and large cash positions.

South Africa's gross external financing needs are large, averaging over 100% of current account receipts (CARs) plus usable reserves. However, they are declining because the current account deficit is narrowing. The trade deficit (surplus in 2016) has seen contraction, but given the small recovery in oil prices (oil constitutes about one-fifth of South Africa's imports) we could see the trade balance weakening again. We could also see weaker domestic demand and a notable increase in exports from the mining and manufacturing sectors, along with a slower pace of increase in imports.

We believe sustained real exports growth is likely to be slow over 2017-2020 because of persistent supply-side constraints to production. Import growth will be compressed amid currency weakness and the subdued domestic economy.

Therefore, we estimate current account deficits will average close to 4% of GDP over 2017-2020. However, South Africa funds part of its current account deficits with portfolio and other investment flows, which could be volatile.

This volatility could stem from global changes in risk appetite; foreign investors reappraising prospective returns in the event of growth or policy slippage in South Africa; or rising interest rates in developed markets.

We consider South Africa's monetary policy flexibility, and its track record in achieving price stability, to be important credit strengths. South Africa continues to pursue a floating exchange rate regime. The South African Reserve Bank (SARB; the central bank) does not have exchange rate targets and does not defend any particular exchange rate level. We assess the SARB as being operationally independent, with transparent and credible policies. The repurchase rate is the bank's most important monetary policy instrument.

Absent large currency depreciations, we expect that inflation will fall back below 6% this year and remain in the target range of 3%-6% over our three-year forecast horizon.

Outlook

The negative outlook reflects our view that political risks will remain elevated this year, and that policy shifts are likely which could undermine fiscal and growth outcomes more than we currently project.

If fiscal and macroeconomic performance deteriorates substantially from our baseline forecasts, we could consider lowering the ratings.

We could revise the outlook to stable if we see political risks reduce and economic growth and/or fiscal outcomes strengthen compared to our baseline projections.


Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year.

Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments.

The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest).

Section V.B of S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 23, 2014, summarizes how the various factors are combined to derive the sovereign foreign currency rating, while section V.C details how the scores are derived. The ratings score snapshot summarizes whether we consider that the individual rating factors listed in our methodology constitute a strength or a weakness to the sovereign credit profile, or whether we consider them to be neutral.

The concepts of "strength", "neutral", or "weakness" are absolute, rather than in relation to sovereigns in a given rating category. Therefore, highly rated sovereigns will typically display more strengths, and lower rated sovereigns more weaknesses. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in assessment of the aforementioned factors does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the assessments.

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee agreed that the institutional and debt burden assessments had deteriorated. All other key rating factors were unchanged.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

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