Last rating standing…

Will they or won’t they? 

The question of whether SA will keep its investment-grade credit rating from Moody’s Investors Service preoccupied financial markets, business and government in the runup to the Treasury’s National Budget delivered on 20 February.

SA dodged the bullet despite news that budget deficits and government debt will rise to worrying levels while growth will likely be slower than expected over the next three years – a combination of factors which would normally trigger a credit rating downgrade. 

The fact that Treasury made plans to cut its bloated public sector wage bill – to partly offset the money it coughed up to keep Eskom solvent – helped to convince Moody’s to hold its fire for the time being.But the suspense will remain for the rest of the year, keeping the rand and government bond market volatile and investors on edge. 

There is a good chance that Moody’s – the last of the three main global credit rating agencies to assess SA’s sovereign debt at investment grade – will change its outlook on the rating from stable to negative in its next scheduled update on the country on 29 March. 

That would give the Treasury 18 to 24 months to improve the country’s deteriorating credit metrics and speed up the structural reforms needed to restore confidence and spur economic growth.

Clarity during the month on the level of electricity tariffs granted to Eskom by the National Electricity Regulator of SA (Nersa), further details on how the power utility will be restructured and official data confirming the economy’s growth rate last year will all feed into that decision.

If Moody’s changes the outlook on SA’s credit rating to negative from stable on 29 March, the likelihood of the rating itself being downgraded this year will increase, putting pressure on domestic financial markets. 

If it does not, the probability of a downgrade in 2019 will fall significantly. 

Most analysts are betting that Moody’s will change the country’s credit rating outlook to negative on that date, although there is still plenty of room for doubt.“It’s in their best interests to make the correct decision – nothing is cast in stone,” says Citigroup economist Gina Schoeman. 

“The easiest decision is the negative outlook in March – it’s justifiable at this point.”    

The next big landmark for Moody’s is the Treasury’s medium-term budget policy statement (MTBPS) in October, which will show whether plans to support struggling state-owned enterprises and reduce their burden on the government’s finances are starting to bear fruit. 

The outcome of the country’s general election in May and the decisions which President Cyril Ramaphosa takes in the months afterwards will also help inform Moody’s assessment of SA’s credit landscape.Some analysts expect Moody’s to downgrade SA’s sovereign credit rating of Baa3 by one notch to sub-investment-grade, or junk status, at its second scheduled assessment for the year in November. 

But if it keeps the outlook on the rating stable in March, it could just change that to negative at that time, extending the period of uncertainty into 2020.

The pressure on Moody’s is intense as it was the only credit rating agency to have given SA’s sovereign debt an investment-grade rating at the start of the democratic era in 1994. 

Both Standard & Poor’s and Fitch have historically been less generous, giving SA an investment-grade rating only years later when the Treasury’s credibility in global markets was well established.

If Moody’s were to nudge its credit rating into junk territory the consequences for SA would be severe – rand-denominated government bonds would fall out of Citigroup’s World Government Bond Index, triggering forced selling of billions of rands worth of those bonds by global pension funds and other institutions, leading to huge capital outflows from the country.

The government’s cost of borrowing would shoot up, along with the debt burden for consumers and business, and the rand would take a beating, fanning inflation and triggering interest rate increases from the Reserve Bank. 

Investment would falter, jobs would be lost and the country’s sluggish pace of growth would slow further, Reserve Bank governor Lesetja Kganyago warned journalists just ahead of finance minister Tito Mboweni’s budget speech. 

He pointed out that the Bank had carried out stress tests for the banking system which showed that in the event of a worst-case scenario, SA’s banking system was capitalised well enough to withstand the shock. 

But his remarks, together with comments from Mboweni on the difficulty of ongoing talks with rating agencies, convinced many journalists that the dreaded downgrade would take place immediately.

Once again, Moody’s gave SA the benefit of the doubt and its official statement after the budget was relatively balanced. 

While the rating agency highlighted the further erosion of the country’s fiscal strength and its limited room to manoeuvre, it noted that SA’s long track record of sticking to its spending framework and making any revisions transparent stood it in good stead. 

Remarks later by Lucie Villa, Moody’s lead sovereign analyst for SA, were even more telling.

“When you look at what the 2019 budget proposes for the next fiscal year, you can see the glass as half-empty or half-full,” she said in an interview with CNBC Africa. 

“Because we’re speaking about fiscal deterioration, I understand why the question is ‘why not a negative outlook?’

“We don’t say ‘if debt is above these levels, then this or that’ – the reason being that it’s very complicated for sovereigns, because different sovereigns can afford different debt levels, depending on the structure of that debt. And South Africa has a favourable debt structure – this is very important. Here, yes, there has been a deterioration – but there is also resilience.”

Villa’s remarks suggest that Moody’s will do everything it can to avoid relegating SA to junk status. 

But unless things change on the country’s debt landscape, there will come a point when its generous approach will cast doubt on its credibility, analysts say.    

“For the market we believe that consensus broadly sees a high probability of an outlook cut in March and that this is priced in to a moderate degree,” says Peter Attard Montalto, head of Capital Markets Research at Intellidex. 

“Consensus and pricing, however, in our view does not see a cut in the rating this year, which we [at Intellidex] pencil in still in November.”

Investec economist Annabel Bishop calculates the probability of a credit rating downgrade this year at just 37%, and says that should the event occur, the fallout for SA would depend on the global economic backdrop. 

US President Donald Trump’s recent decision to delay imposing further trade tariffs on China, coupled with signals that the US Federal Reserve will be cautious over further interest rate hikes, has allayed concerns over a global slowdown and been positive for emerging markets like SA.

The rand has strengthened back to the level it was at just ahead of the budget, and is hovering at R13.85 against the dollar after a spike to R14.37 at one point during Mboweni’s budget speech in Parliament. 

In her base-case scenario, Bishop sees the currency ending this year at R13.05 against the  dollar and the Reserve Bank’s main repo rate at 7.%, up from 6.75 % now. 

In the event of a downgrade, she thinks the currency could end this year at R18.50 to the dollar and the repo rate at 8.5%. 

Growth remains weak 

Another topic of debate emerging from the budget is the pace of SA’s economic growth this year, which is expected to accelerate from a meagre estimate of 0.7% in 2018.

The Treasury lowered its forecasts for this year and next to 1.5% and 1.7% respectively, from 1.7% and 2.1% last October. 

Economists are split on the likely outcome, although many believe the official estimates are a bit too optimistic – as they have turned out to be in each of the last four years.

Citigroup’s Gina Schoeman is at the bottom of the scale, with an economic growth forecast of just 1.1% in 2019 and 1.6% in 2020. 

She says her forecasts will be upgraded if tangible reforms are announced after the election, but that although these would immediately boost confidence, it would take time for a knock-on, direct impact on growth.

“The private sector doesn’t expand on blind faith, it expands on certainty and economic growth. It waits to see what you reform and how, and whether that benefits growth. That is why this takes a long time, that is why I can’t see a lot of growth too soon,” she says. 

As the risk of a Moody’s downgrade will remain alive for the rest of this year, uncertainty would persist, she adds.

There is a long way to go before the private sector is ready to pump money into SA’s economy – the latest business confidence survey from the Bureau for Economic Research and Rand Merchant Bank showed a dip in the third quarter of last year, with seven out of ten respondents unhappy with prevailing conditions.

Treasury is nonetheless forecasting a strong recovery in gross fixed capital formation, the country’s key investment indicator, predicting it will grow by 1.5% this year and 2.1 % in 2020, compared with -0.2% in 2018 and 0.4% in 2017.    

Many economists also believe that consumer spending is unlikely to accelerate this year, despite the fact that Treasury did not raise personal income taxes in the budget or make any changes that would have a significant direct impact on individuals. 

However, its decision to not adjust income tax brackets for inflation, in order to raise R12.8bn for the fiscus, will weigh heavily on the mood of consumers.

“It will be less of a support mechanism to the economy and more of a pause in the pain – no one is  out there rejoicing, they are just relieved,” says PwC economist Christie Viljoen. 

South Africans were still adjusting to increases in their tax burden over the last three years, which included a hike in the VAT rate and personal income taxes, he added. 

PwC sees the economy expanding at a pace of 1.4% this year.    

Another negative factor for consumers is that for Nersa to raise electricity tariffs enough to significantly boost Eskom’s revenue and satisfy rating agencies, the hike would have to be at least 10% over each of the coming three years.    

Reinforcing the gloom, South Africa’s leading business cycle indicator – which points to economic trends a year in advance – declined in  November, according to official data released on 26 February. 

Investec economist Annabel Bishop says the fact that the forward-looking indicators relevant to the first three quarters of this year have all contracted is “of grave concern”.

But there are still optimists out there and Standard Chartered economist Razia Khan is at the top end of the economic growth forecasting scale. 

She believes Treasury’s growth forecasts are far too conservative and that tax collected by the South African Revenue Service will improve significantly following the steps taken to shore up compliance after years of erosion under former president Jacob Zuma. 

She sees the economy growing by 2% this year, and picking up steam in 2020.

Mariam Isa is a freelance journalist who came to SA in 2000 as chief financial correspondent for Reuters news agency after working in the Middle East, the UK and Sweden, covering topics ranging from war to oil, as well as politics and economics. She joined Business Day as economics editor in 2007 and left in 2014 to write on a wider range of subjects for several publications in SA and in the UK. 

This article originally appeared in the 7 March edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.