As finance minister Tito Mboweni prepares to deliver the 2019 budget, all eyes are on government’s plans for Eskom, and how ratings agency’s will respond to them.
Moody’s Investors Service is the last of the three major credit rating agencies to keep SA’s credit rating at investment grade level.
S&P and Fitch both downgraded SA to junk status in 2018, in response to the surprise cabinet reshuffle and an unfavourable mid-term budget in October 2017.
Moody’s downgraded SA’s sovereign ratings to the cusp of junk in June 2017, warning that the country could lose its investment-grade rating if its economic and fiscal strength continued to falter.
A further credit rating downgrade by Moody’s would therefore take its credit rating on South African bonds also down to junk status.
According to Intellidex analyst, Peter Attard Montalto, while there is some view in the market that an immediate Moody’s downgrade could happen on Friday after the budget, it is not likely.
“This is theoretically possible if there was such a large shock on Eskom or core fiscal, but we think of very low probability. Indeed the fact Moody’s is undertaking a call with a bank straight after the budget would further suggest the low probability of a cut,” he said.
More likely, and more Moody’s style, is to do a trip and wait till their schedule date on 29th March, even if they are meaningfully shocked next week, Attard Montalto said.
A downgrade to sub-investment grade would see SA expelled from the Citi World Government Bond Index (WGBI), prompting asset managers and pension funds to sell domestic bonds.
“This would sharply increase the cost of debt and put further pressure on the exchange rate,” said Ian Matthews, head of Business Development at Bravura.
What will drive a downgrade
According to Intellidex, the main driver of the budget will be Eskom – and what government plans to pull the company from the brink.
“The key will clearly be the Eskom bailout which has been specifically promised on numerous occasions at and since SONA,” it said.
“Expectations are fully loaded that something ‘must’ happen – but the form and quantum are unclear. Despite wide ranging discussions with investors, we struggle really to get a full sense of where consensus is.
The group holds a baseline expectation that a R100 billion debt swap will happen, with a commitment to fill any remainder hole with equity transfers – but this isn’t a “high conviction view”, it said.
“We have highlighted a higher probability that ‘nothing’ will happen. What is disappointing is that no white paper on Eskom is likely pre-budget, which we think leaves a credibility hole of what exactly a bailout is being provided for, structurally and policy wise.
“From their update a week ago, Moody’s seems to share the same view,” the group said.
While Intellidex expects negative notes from S&P and Fitch, it does not anticipate further downgrades from the groups at this point. For Moody’s, it expects a negative outlook at the end of March, with a cut to happen in November.
Eskom is the biggest risk
This is echoed by Bravura’s Matthews, who said that Moody’s already appears unconvinced about the proposed plan to save Eskom through dividing it into three parts – adding that the utility remains South Africa’s single biggest risk to fiscal and economic stability.
“This, in combination with a poor tax collection revenue is going to make the ratings agency hard pressed to find reasons to keep the country at an investment rating,” he said.
The 2018 mid-term budget policy statement (MTBPS) already highlighted the weaknesses in South Africa’s credit rating, pointing to a relatively high share of foreign ownership leaving South Africa vulnerable to sudden shifts in investor sentiment.
“While most government debt is denominated in rands, reducing South Africa’s exposure to external volatility, non-residents hold 38% of South African foreign and domestic government debt,” Mboweni said in October.
What can be done to avoid a downgrade
According to consultancy group, PwC, to appease credit rating agencies, Mboweni will need to talk to three specific issues during his budget speech: the pace of fiscal consolidation, reforms in SOEs (especially Eskom) and measures to lift economic growth.
“By effectively outlining a path forward for South Africa’s fiscus, the minister will be able to satisfy credit rating agencies and would steer the economy away from a sub-investment grade,” the group said.
The fiscal budget for 2019/20 will likely contain difficult prioritisation decisions to ensure that government can meet its fiscal consolidation objectives and appease rating agencies.
The public sector wage bill and SOE finances will be top of mind, as National Treasury looks for ways to reign in growing government debt and bring the fiscal deficit down to more manageable levels, PwC said.
In spite of limited fiscal room, the focus of the 2019/20 fiscal budget must also fall on measures to stimulate investor confidence and reignite economic growth.
“Without prospects of an economic growth recovery, South Africa’s fiscal situation will likely remain constrained in coming years,” it said.