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Credit rating downgrade very likely - economist

Sep 30 2016 16:32
Liesl Peyper

Cape Town - A quick glance at the factors that influence a country’s credit rating suggests that South Africa could indeed be in store for a sub-investment grade rating, says economist Arthur Kamp of Sanlam Investment Management.

In a company note issued on Friday, Kamp said South Africa’s GDP per capita level is declining, potential growth is low, the current account deficit is relatively large, the government's main budget deficit remains wide, policy uncertainty has escalated over the past year and the economy does not count among the most developed economies.

Looking at these factors, South Africa is, indeed, at risk of being assigned a sub-investment grade rating, Kamp said. 

Yet, ratings agencies Standard & Poor’s, Moody’s and Fitch have all held back on credit rating downgrades in the recent past. This, Kamp believes, can be attributed to the strength of National Treasury and the South African Reserve Bank (Sarb). 

Of all the ratings agencies Moody’s is currently the most optimistic, rating South Africa’s sovereign credit at two notches above junk status. The agency earlier said the chances of a credit rating downgrade is less than 50%, but a ratings cut from Moody’s would put South Africa in line with the rating assigned by Fitch and S&P at one notch above junk. 

A number of analysts have predicted that at least one of the three major ratings agencies will downgrade South Africa to junk status by the end of 2016. 

Kamp emphasises that National Treasury has built a solid track record in recent years of sticking to its expenditure ceiling, although expenditure has been rising relative to GDP, given the underperformance of the economy.

READ: Moody’s sees one-third probability of SA downgrade

“Moreover, its intent and willingness to stabilise the debt ratio and return government's finances to long-term sustainability are clearly illustrated in the actual and projected decline over the next three years in the primary budget deficit.” 

On its own, Treasury cannot sustain the sovereign debt rating in investment grade territory. But there is some potentially good news, says Kamp. 

The current account deficit shrank from 5.3% of GDP in the first quarter of 2016, to 3.1% of GDP in the second quarter. And the advance in real GDP recovered from an outright fall of 1.2% in the first quarter to an increase of 3.3% in the second quarter. 

READ: SA staves off technical recession, economy grows 3.3% in Q2

“GDP growth is unlikely to sustain this pace in the third quarter, but given the nascent increase in South Africa's terms of trade, the better trade data and the possibility of an improved relative performance from agricultural production, a recovery in real economic activity, albeit tepid, appears to be on the cards by 2017. 

“Moreover, inflation is expected to peak in late 2016, before slowing through next year. This augurs well for the short-term interest rate outlook. Maybe, just maybe, this helps South Africa stave off the drop to junk status,” according to Kamp. 

READ: Resilient SA economy can still avoid downgrade - Gordhan

He points out though that the market already priced in a sub-investment grade status in South Africa. “Even if South Africa's foreign currency debt is downgraded to junk, Credit Default Swap (CDS) spreads indicate in mid-September 2016 the market had already priced in sub-investment grade status broadly in line with countries such as Brazil, Turkey and Russia.”

Unanticipated events, such as a more aggressive tightening by the US Federal Reserve than currently expected or heightened economic policy uncertainty in South Africa, could change the outlook, Kamp says. 

"But the point is that South Africa is already paying for the expectation of junk status. Borrowing costs are already higher than they would have been. And, arguably, the rand is weaker than it would have been (implying the same goes for inflation and implicitly, short-term interest rates).” 

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