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Ratings risk remains for South Africa - experts

Cape Town - South Africans can head into the festive season feeling a bit more at ease, knowing that the country has maintained its investment grade rating.

However, there is still work to be done, according to Dave Mohr, chief investment strategist, and Izak Odendaal, investment strategist at Old Mutual Multi Managers (OMMM).

All three rating agencies, S&P, Moody’s and Fitch, have retained South Africa in an investment grade.

"As it stands now, both Fitch and S&P rate South Africa only one notch above sub-investment (or junk) status. Both have a negative outlook, suggesting that the next ratings move is down," said  Mohr and Odendaal.

"We can therefore experience a repeat of the recent stressful period in 2017. Faster growth is needed to avoid a downgrade in future as economic growth ultimately ensures that debt levels are sustainable."

They said credit ratings tend to tell the market what it already knows, noting that a US interest rate hike poses a bigger challenge to bond market compared to credit agencies.

"Looking to 2017, the bigger risk to our bond market remains US interest rate developments, rather than credit ratings," said Mohr and Odendaal.

They explained that if the US Federal Reserve (Fed) hikes interest rates aggressively (by more than is currently priced in) the result is likely to be a much stronger dollar, which could result in a weaker rand, putting upward pressure on local inflation and interest rates.

"This would be bad for bonds and the local economic growth outlook, which has recently improved."

They said he Fed is almost certain to hike their funds rate later this month. Inflation has been rising gradually, but remains below the Fed’s 2% target. Annual US personal consumption inflation (the Fed’s preferred measure of price pressures) increased to 1.4% in October, while it was only 0.3% a year ago.
Excluding the impact of volatile food and energy prices, inflation was 1.7%. Meanwhile, unemployment fell to 4.6% in November, almost the lowest level in a decade. However, despite unemployment falling and employment growth of around 1.6% per year, wages have not responded much to the tighter labour market, growing by 2.5%.

Therefore, while the Fed is expected to increase interest rates, it is likely to do so gradually, said Mohr and Odendaal.

Deflation scare behind us

The big decline in the oil price in 2014 and 2015 contributed to the past year’s global deflation scare. In turn, this added to interest rates staying flat in the US and falling to below zero in Europe and Japan. The oil price has now rebounded again thanks to a larger-than-expected agreed production cut by the Organisation of Petroleum Exporting Countries (OPEC) of 1.2 million barrels per day (with Saudi Arabia responsible for around half of the cut).

However, the challenge for OPEC has traditionally been getting members to stick to their quotas, given the incentive to cheap (i.e. produce more at the higher price). This incentive is even greater now, given that North American shale producers will also benefit from the higher price.

Even at Friday’s closing price of $54 per barrel, the average oil price of 2016 is still lower than in 2015 ($43 vs $52).

The SA Reserve Bank assumed an average oil price of $53 per barrel in 2017, so the latest move does not dramatically alter the local inflation or interest rate outlook.

The steady rand, which is now slightly stronger against the US dollar than a year ago (despite global upheaval), helps to offset the impact of the higher oil price.

Meanwhile, credit growth remains weak, especially household borrowing, confirming that there is little demand pressure on local prices. Loans and advances only grew by 5.8% year-on-year in October, down from 8.5% growth at the start of the year. Mortgage growth is only 5.4%.

Oil helped the trade balance

Mohr and Odendaal said the lower oil price in 2016 has been a factor behind the improving trade balance.

South Africa posted a R4.4bn trade deficit in October, but this was smaller than expected. October is typically a large deficit month as imports surge ahead of the festive season.

The trade deficit for the first ten months of the year was only R14bn, compared to R60bn over the same period last year. Over the same comparative period, the value of oil imports fell by 17%.

"Therefore, a sustained rise in oil prices threatens this improvement."

Although South Africa is not as well integrated into global value chains as it could be, Mohr and Odendaal said that faster global growth bodes well as we head into 2017.

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