One should always celebrate the good news. And the Moody’s note which left South Africa’s credit rating unchanged over the weekend was one such point. The Investor Service did however assign a negative outlook, which should keep government on its toes, as the country shows slight improvement but isn’t out of shark infested waters just yet. The next big hurdle to overcome is due in June when both Standard and Poor’s and Fitch issue their updated credit scores. S&P has the country one notch above junk, while Fitch sits two. Stanlib’s chief economist Kevin Lings gives a positive assessment of Moody’s rating below. Let’s hope this positivity is carried through into next month.
On 6 May 2016, Moody’s Investors Service confirmed South Africa’s sovereign rating at Baa2, although the rating was assigned a negative outlook. The decision by Moody’s to leave South Africa’s sovereign credit rating unchanged is a surprise given that the rating is currently one notch above both Fitch (stable outlook) and S&P (negative outlook). In addition, Moody’s has had South Africa on a negative credit outlook since 15 December 2015. Overall, the statement issued by Moody’s was very upbeat, mostly highlighting positive aspects.
According to Moody’s, although the negative outlook on the credit rating was left unchanged, the country is likely approaching a turning point after several years of falling growth; that the 2016/17 budget and medium term fiscal plan will likely stabilize and eventually reduce the general government debt metrics; and that recent political developments, while disruptive, testify to the underlying strength of South Africa’s institutions.
Importantly, Moody’s made no changes to South Africa’s local or foreign currency country ceilings, which remain at A1 for local currency debt and deposits, A2 for foreign currency debt and Baa2 for foreign currency bank deposits.
In making their ratings decision, Moody’s made the following key points (all positive):
- Moody’s expectation is that South Africa’s economic growth will gradually strengthen after reaching a trough this year, as the various supply-side shocks that have suppressed economic activity since 2014 recede.
- Specifically, the electricity supply is now more reliable, the drought is ending and the number of work days lost to strikes has shrunk significantly (a trend that planned rule changes are likely to embed further).
- The inflation outlook is more subdued, which would suggest fewer interest rate rises ahead than Moody’s expected when the South African Reserve Bank saw inflation heading towards 8% by year end. Less severe tightening of monetary policy would alleviate extra pressure on South Africa’s relatively highly-indebted household sector and support growth.
- South Africa has a more competitive exchange rate.
- The adoption of more aggressive consolidating measures in the recent budget increases the likelihood that the general government gross debt to GDP ratio will stabilise in the current fiscal year at around the current level of 51%.
- For the first time since the global financial crisis, the government has pledged to achieve a primary surplus on the consolidated government account in 2016/17, as well as in the main budget the following year, with surpluses scheduled to grow each year thereafter.
- The government’s recent track record of achieving fiscal targets lends weight to their future plans: the principal driver of the rising debt ratio in recent years has been lower-than-expected GDP growth since targets for revenue, spending and deficits were largely met even when growth fell short.
- The authorities have made conservative forecasts for revenue over the coming three years, including in terms of expected receipts generated from future tax increases, providing reassurance that such ambitious deficit targets can be achieved.
- Government’s budget displays a high degree of flexibility. The authorities have reestablished a small unallocated spending buffer in the new budget framework and also have been able to shift existing allocations to other emerging needs such as drought relief and higher education spending.
- The authorities have also stated that expensive new projects such as the construction of massive nuclear power facilities and national health insurance will be developed only at the pace and scale that the budget allows.
- Moody’s continues to assess South Africa’s institutional strength as high, notwithstanding recent corruption scandals.
- South Africa’s monetary and fiscal institutions have proven to be sound over time.
- The reappointment of a respected former finance minister to the post following the intervention of the ANC leadership late last year, along with the more ambitious budget that the minister tabled in February, demonstrated determination to bring the public finances under control.
- The Constitutional Court judgment against the president attest to the strength and independence of South Africa’s constitution and judicial system and renewed attentiveness to bringing corruption out into the open and maintaining the rule of law.
- The local government elections, scheduled for 3 August this year, will be a litmus test as to whether and by how much these developments are eroding the ANC’s electoral support and the consequences for the robustness and clarity of economic and fiscal policy.
The above factors, according to Moody’s are likely to strengthen growth in South Africa from the second half of this year and thereafter. While Moody’s expects the economy to expand by only 0.5% in 2016 (STANLIB 0.5%), they expect growth to rise to 1.5% in 2017 (STANLIB 1.2%). In addition, Moody’s argues that ongoing structural reforms and diminished infrastructure bottlenecks offer upside potential for growth over the medium term. Furthermore, the recent rapprochement between the government, business and labour holds promise from the standpoint of identifying areas of mutual concern. The rationalisation of state-owned enterprises (SOEs) and the enactment of labour market reforms have been identified in the process.
In assigning South Africa a negative ratings outlook, Moody’s highlighted the following key points:
- Downside risks associated with the growth, fiscal and political outlook, and the possibility that renewed volatility in global financial markets could increase external imbalances and disrupt growth.
- While the government has taken important first steps towards fiscal consolidation, deeper structural reforms to restore business confidence and raise the economy’s growth potential are in their very early stages.
- Over the near term, growth (and therefore the strength of the government’s balance sheet) will remain sensitive to consumer and investor confidence regarding the prospects for reform and efforts to distance the policymaking process from corruption scandals.
The outlook for South Africa’s credit rating will depend on government’s success in enhancing medium term growth and in arresting the deterioration in the government’s balance sheet. Moody’s also indicated that they would likely downgrade South Africa’s rating if economic growth were to fail to revive, if government’s debt position failed to improve, or if investor confidence were to decline by such an extent that external financing was insufficient to fund the current account deficit on an extended basis. The failure of social partners to implement policies or measures that would secure a healthier investor climate and attract increased private investment would also be negative. Finally, Moody’s could downgrade South Africa’s rating should the government unduly delay enacting reforms that would address fundamental economic rigidities and enhance competitiveness.
In contrast, Moody’s could change the rating outlook from negative to stable if the government were to deliver on commitments that support growth and achieve the pledged stabilisation and eventual reduction in general government debt. Measures to win back business confidence (such as rationalising the state-owned enterprise sector, clarifying Black Economic Empowerment (BEE) regulation and expanding the Independent Power Producer (IPP) framework into new areas of infrastructure), would also be credit positive.
Overall, not only did Moody’s surprise the market by keeping the rating unchanged, but the statement that accompanied the ratings decision was extremely positive given recent economic and political events. It is clear that Moody’s was impressed by the February 2016 National Budget as well as government’s intention to improve the country’s growth outlook. On reflection, Moody’s flagged very few negatives, and their statement contrasts substantially with recent views expressed by both S&P and Fitch.
The next big rating decision will be S&P’s rating update on 3 June 2016, followed by Fitch’s ratings review, also in June 2016.
Article by Kevin Lings (Chief economist at Stanlib)