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Although South Africa’s credit ratings are on a long-term deteriorating trend, it is slow moving and a downgrade to junk status is not the “base case scenario”. This is according to Peter Worthington, senior macro economist at Corporate and Investment Banking, Barclays Africa.
Worthington highlights three main reasons why Brazil is different to South Africa.
1. The politics
In Brazil, the politics are “incredibly fragmented and fractured,” says Worthington. President Dilma Rousseff has very little political capital as government has to deal with a number of opposition parties and coalitions.
Implementing policy is a much harder task for the Brazilian government. In South Africa much of the policy is determined by the ANC and implemented without much opposition.
2. Brazil’s difficult debt dynamics
Brazil has a much higher share of government and corporate debt denominated in currency, making their debt dynamics more difficult than South Africa’s. “That means currency depreciation for them has a real sting in its tail,” says Worthington.
On the contrary, a weaker currency is a good thing for South Africa, especially as it is not “inflated away”. Brazil’s Central Bank is less flexible in its inflation targeting than the South African Reserve Bank. This is probably due to Brazil’s history of hyperinflation, says Worthington.
The consequence is that in Brazil the real interest rates are extremely high. “If you have a very high real interest rate, you need a much higher primary budget surplus to offset that,” he says. The real interest rate is offset by the growth rate and primary budget surplus; however Brazil’s economy may be heading for a contraction this year.
3. Brazil’s troubled fiscal system
A country’s fiscal performance is important for credit ratings and weak growth hurts revenues in the budget. The Brazilian state has a higher share of mandatory obligations like benefit pensions. Tampering with them could lead to legal challenges, and a “flurry of opposition” from congress.
Fiscal adjustment is harder in Brazil. The deteriorating fiscal policy and the implications on debt obligations contributed to ratings agencies downgrading Brazil to sub-investment grade, explains Worthington.
In South Africa, it is expected that finance minister Nhlanhla Nene will include downward revisions to revenue when he announces the mid-term budget speech later in October.
Nene faces the challenges of breaching the nominal expenditure ceiling. “That nominal expenditure ceiling has been sacrosanct and if they breach it the ratings agencies will not look kindly at it,” says Worthington.
Two big fiscal risks weighing down on expenditure include the financing of state-owned enterprises by selling assets, as was seen with the R23bn financial injection into Eskom financed from the Vodacom sale.
It is yet to be seen if Treasury will be able to “stick” to these commitments once funding runs low. The nuclear deal also contributes to the risk, has huge upfront costs, and we may not need the energy anyway, says Worthington.
Rating agencies prefer not to downgrade countries below sub-investment grade because they do not want to be accused of precipitating a crisis that may have been avoided, says Worthington. This is why a number of countries are “bunched up” above the sub-investment grade threshold, with negative outlooks.
Ratings agencies are waiting until the economic and political evidence becomes “absolutely overwhelming” before pushing countries down to junk status. In South Africa that’s not the case at the moment, says Worthington.
Ratings agencies will first put South Africa in a negative outlook, before downgrading to junk. If Fitch downgrades South Africa it would be to BBB- level, matching S&P’s level, which is a notch above sub-investment grade.
