‘Junk status not yet a done deal for SA'

Cape Town - South Africa may once again dodge the downgrade bullet when ratings agencies Moody’s and Standard & Poor’s announce their decisions on Friday and next week, respectively.

This is the view of Renier de Bruyn, equity analyst at Sanlam Private Wealth, who opines that a downward adjustment to South Africa’s sovereign credit rating is not a given. 

“Although turmoil and uncertainty on the political front may yet prove to be the final decider for the ratings agencies, many industry players and observers now believe the feared downgrade at the end of the year is not yet a done deal.”

De Bruyn points out that a ratings review is about judging South Africa’s creditworthiness.

“The stabilisation of commodity prices during 2016 has led to increased optimism, as has the expectation that we may now be nearing the end of the drought.

"The recovery of the rand has also played a significant role in the outlook for inflation and interest rates. On balance, these events have all contributed to marginally better growth prospects and an improved ability to service debt.”

The peaceful municipal elections with a shift towards more support for opposition parties as well as “victories” for the Public Protector and the National Treasury have confirmed the strength of some of South Africa’s institutions, said De Bruyn.

“Furthermore, initiatives towards better cooperation between government, labour and business to avert a downgrade have certainly counted in our favour.”

There’s much speculation that the rating decision will hinge on political events, such as the student protests or whether President Jacob Zuma stays in office.

“However, the rating agencies predominantly base their decisions on the numbers,” De Bruyn said, “with particular emphasis on South Africa’s longer term economic growth outlook, and whether they’re confident that our government will manage the country’s finances prudently. The credibility of our Finance Minister and his Treasury plays a crucial role.”

Rating agencies have been sympathetic towards South Africa’s current lack of economic growth, influenced by weak external demand, which has had an impact on exports, as well as the drought, which they see as temporary, De Bruyn said.

“The expectation is that economic growth will start recovering into 2017 as these headwinds dissipate. Other positives include the more reliable electricity supply, which had previously hampered growth, as well as an improved outlook for inflation following the recovery of the rand, and prospects for lower food prices, which may open the door for interest rate cuts next year.”

According to De Bruyn, the major rating agencies still assess South Africa’s institutional strength as high. “It’s in this arena where political instability has the potential of accelerating a downgrade decision.

“If we can avert this, then the next step to retaining our investment-grade rating is to prove that we can reignite longer term economic growth by introducing the necessary structural economic reforms that will make South Africa a more business-friendly environment.”

He points out that the imminent threat of a downgrade has provided the impetus for better cooperation between government, business and labour.

“But it remains to be seen whether policymakers will eventually push through the necessary reforms in the future given the various vested interests and social demands.”

Impact of ‘junk status’

Although it’s hard to find any positive outcomes for South Africa’s economy in the event of a downgrade, De Bruyn expects such an event may not have much impact.

“If one looks at how the markets of countries that have lost their investment grade rating in recent years performed before and after becoming ‘junk’, it’s clear that in general, the currency, equity prices, budget and current account deficits deteriorated in the run-up to being downgraded, but then stabilised and often improved after the event,” he said.

The muted reaction of the markets after those downgrades was a result of asset prices having moved “ahead” of the event.

“The most direct impact of a lower credit rating would be seen in the cost of South Africa’s foreign-denominated debt,” said De Bruyn.

In addition, a distinction should be made between the credit ratings of local versus foreign currency debt.

“South Africa’s rand-denominated debt is rated higher than its foreign currency debt and therefore has a lower chance of losing its investment-grade status. The rand debt rating is also more relevant, as only 10% of government debt is denominated in foreign currency,” De Bruyn said.