Global ratings group Moody’s has published a research report on South Africa, with insight into its decision to let its traditional review date pass without action – leaving the country’s sovereign credit rating at investment grade.
The rand reacted positively to Moody’s ‘no rating downgrade’ on Monday, gaining 2% against the dollar, and it remained on the front foot in trade on Tuesday due to the better risk sentiment in the market, said Andre Botha, a senior dealer at TreasuryONE.
Economists and analysts had anticipated a ratings decision from the group on Friday, 29 March, following the latest bout of load shedding, a cut in GDP growth forecast, and the most recent MPC decision to hold interest rates.
While Friday was one of two dates on Moody’s calendar in 2019 (the other being November), it is not uncommon for these dates to pass without activity.
And after Moody’s elected not to publish a ratings update on Friday, analysts suggested that the ratings firm had likely decided to wait until after the national elections, taking place on 8 May.
The reprieve, which was seen as affirming South Africa’s rating at one notch above junk (Baa3), was welcomed by the South African government, seeing it as an affirmation of the country’s rating at one notch above junk (Baa3).
Moody’s is the last major ratings agency to hold South Africa’s credit rating above investment grade, with S&P Global and Fitch having downgraded the country in 2017.
How Moody’s sees South Africa
In a new report published on Tuesday, Moody’s highlighted that while the local economy faces many problems, it still falls inline with other sovereigns that are all rated Baa3.
Eskom, and SOEs in general, remain a huge risk, and an unreliable electricity supply exacerbates labour and skills issues – but South Africa has proven to be resilient, with strong core institutions and a solid finance sector.
The group highlighted the following strengths and weaknesses:
Credit strengths
- Sustained strength of core institutions such as the judiciary and the Reserve Bank;
- A well-capitalised banking sector and relatively deep financial markets;
- Low share of foreign-currency liabilities for the government and broader economy.
Credit challenges
- Deep-rooted social and political divisions that hamper reform advancements and generate policy uncertainty;
- Structural economic bottlenecks that limit growth potential and employment;
- Weak state-owned enterprises sector.
Elections
Moody’s said that the gradual implementation of the reform agenda of the new (Ramaphosa) administration, combined with the reduction in political uncertainty following the May elections will likely have a positive impact on South Africa.
This will be through boosting confidence and the improvement of economic conditions.
However, the country will still face significant ‘supply-side’ problems – particularly with an unreliable electricity supply and a skills shortage which will constrain job creation. The country’s high unemployment rate is unlikely to be improved any time soon, it said.
Eskom
“Eskom will remain the main source of contingent liability risk for the government,” Moody’s said.
The power utility’s debt amounts to around 8% of GDP, of which 5% of GDP benefits from government guarantees, it noted.
“Capital transfers from the government, combined with the tariff increases announced by the National Energy Regulator of South Africa (NERSA) in March, which were below what was requested by Eskom, may prove insufficient to address the company’s long-standing financial troubles,” Moody’s said.
Economic review
“While economic growth will remain slow and fiscal strength will continue eroding, we expect South Africa’s credit profile to remain in line with those of Baa3-rated sovereigns.
“We expect that government’s policies and institutions will remain focused on addressing this trend, but any reversal will be gradual at best, given that social, economic and fiscal policy objectives remain difficult to reconcile,” Moody’s said.
The ratings firm said that the successful implementation of structural reforms to raise potential growth and stabilise and eventually reduce the government’s debt burden – could help South Africa raise its credit rating.
However, if debt and contingent liabilities risk from SOEs continue to rise to levels no longer consistent with a Baa3, a downgrade will be more likely.
This is how the group rates the various credit considerations in South Africa:
- Economic strength – moderate (+)
“The slow growth and productivity gains are mostly due to domestic constraints but external conditions have added headwinds, especially from global trade tensions,” Moody’s said.
“A number of structural challenges hamper growth, such as the limited flexibility in the labor market as well as skills shortages that result in an increasingly high unemployment rate, at 27% at end of 2018, persisting regulatory uncertainty in the mining sector, the lack of competition in network sectors and the weak governance of state-owned enterprises.”
- Institutional strength – moderate (+)
Reduced from high (-) due to the gradual deterioration in the country’s institutions in recent years, as exhibited by high-level corruption and ‘state capture’.
“While decisions taken by the government in relation to governance matters offer the prospect that institutional deterioration has halted, it will likely take time for the country to tackle those issues.”
- Fiscal strength – moderate (+)
“National Treasury has largely adhered to expenditure ceilings which have helped contain spending net of interest. However, the collection of tax revenues has been constrained by low growth and the diminished effectiveness of the South African Revenue Service.”
- Susceptibility to event risk – low (+)
This category is largely driven by “domestic political risk”, Moody’s said, which includes the recent changes in South Africa’s political landscape, “which lower the risk of a further erosion of institutional strength and offer the prospect of renewed reform efforts, balanced against a history of political infighting that has generated policy uncertainty in the past”.
- Current account deficit – low
“While high non-FDI inflows make the country vulnerable to “sudden stops” (abrupt shift in investor’s appetite), the external balance has proven resilient to shocks. A flexible exchange rate, low external debt in foreign-currency and relatively large external assets (as reflected by the positive Net International Investment Position) serve as buffers.”
- Government liquidity risk – low
“While the government can access domestically a deep financial sector, it has relied on foreign investors with around 47% of government bonds being held by non-residents,” Moody’s said.
In the current and next fiscal years, the government faces moderate funding needs of about 11% of GDP, including the roll-over of 6% of GDP in Treasury bills, in line with what the government funded in fiscal 2017.
- Banking sector risk – low
“The tightening of credit standards that began in 2015 has helped banks reduce their exposure to the household sector, which is the most vulnerable to interest rate shocks, and redirect it towards corporates that have a better debt-servicing capacity.”
