South Africa’s best city is crawling out of junk

Ratings agency Moody’s has upgraded the City of Cape Town’s investment rating, although it remains in junk status alongside South Africa as a whole.

Moody’s upgraded the City of Cape Town’s long-term issuer rating from Ba3 to Ba2. According to Moody’s rating scales, this is two notches below the investment grade ranking of Baa3.

This is also the highest rating among South Africa’s major metros recently rated. It’s one notch above The City of Johannesburg (rated Ba3 in June 2024) and far above Tshwane and Ekurhuleni (rated Caa2 in March 2024).

Joburg is three notches deep into junk status, while Tshwane and Ekurhuleni are eight levels down into junk.

South Africa’s credit rating was affirmed at Ba2 in December 2024.

Debt from non-investment-grade issuers is commonly termed “junk” and indicates a greater risk of default. This increases costs for the issuers, as investors will demand greater yields from the increased risk.

The city’s Baseline Credit Assessment (BCA) and the senior unsecured MTN program rating were also upgraded from ba3 to ba2.

However, Cape Town’s long-term national scale (NSR) issuer rating, which looks at the creditworthiness of issuers in the same country, was upgraded from Aa3.za to Aa2.za.

This makes Cape Town an investment-grade debt issuer in the South African context. The city’s outlook was also upgraded from positive to stable.

Moody’s said that the upgrade reflects the city’s strong financial management practices, which underpin its ability to maintain consistently robust operating performance and robust liquidity.

This comes despite a backdrop of tight financial conditions and a low-growth environment.

“Cape Town has undertaken various initiatives aimed at enhancing revenue collection and managing expenditure growth, strengthening its credit profile,” said Moody’s.

“The city has also ramped up expenditure to reduce its vulnerability to load shedding by Eskom, B2, stable, and enhance water security.”

The city plans to invest R23 billion in infrastructure over the next two years to enhance its resilience to climate risks.

“These initiatives help to address vulnerabilities that have weighed on the rating, primarily related to rising liquidity pressures, significant shortfalls in revenue collection.”

Cape Town’s financial management has led to a slow but steady improvement in its operating margin, which grew from 11% in the 2023 fiscal year to 13% a year later.

This improvement is related to a structural increase in revenue collection from electricity sales, a key tax revenue component.

Although the national government also supports the city’s budget, Cape Town generates 82% of its revenue from its own sources, such as taxes and service charges.

A new tariff strategy should bring relief for lower-income households and support sustainable services and infrastructure in the future, allowing the city to generate more revenue. 

Best city in the world

Cape Town was recently named the best city in the world by TimeOut magazine. Voters praised the city’s food, nightlife, culture, affordability, happiness, and vibe.

In addition to its natural beauty, the city has better governance than other cities in the country and has seen an influx of South Africans from different parts of the country.

Although the city’s credit rating has been upgraded, the likelihood of another upgrade soon remains unlikely due to the national government’s “junk” rating.

Due to persistent operating surpluses, Moody’s expects Cape Town’s debt burden to remain moderate compared to its international peers.

“Strengthened tax collection rates will support structural revenue growth, increasing the city’s self-funding capacity and reducing borrowing needs versus planned requirements,” said Moody’s.

The practice is to maintain its borrowing levels at levels set by the National Treasury, ensuring that the ratio of debt to operating revenue does not exceed the benchmark of 45%.

Strong financial management allows the city to generate sufficient cash to fund the remainder from existing liquidity and operating cash flows.

Cape Town’s Ba2 rating notably assumes a low likelihood of extraordinary support from the South African government in the event of acute liquidity stress.

Moreover, an upgrade in the city’s rating will require a similar change in the sovereign rating, as the city is rated at the same level as the sovereign. This assumes that the city’s performance remained consistent over time.

On the other hand, a downgrade in South Africa’s sovereign rating will also lead to a downgrade of Cape Town’s rating.

A downgrade could also occur due to financial deterioration driven by reduced operating margins, an unexpected sharp increase in debt, or the emergence of liquidity risks.