6 events that could trigger more downgrades for South Africa

South Africa sunk deeper into junk territory last week after Moody’s Investors Service joined Fitch Ratings in lowering the country’s credit ratings.

Moody’s downgraded both ratings to Baa2 and maintained a negative outlook due to a further expected weakening in SA’s fiscal strength.

Fitch downgraded both ratings to BB- and maintained a negative outlook to reflect high and rising debt, very low trend growth and extreme inequality.

Standard and Poor’s Global Ratings (S&P) on Friday kept its assessment of South Africa’s foreign-currency debt three levels below investment grade, with a stable outlook.

Reasons for rating decision:

Fitch downgraded South Africa’s long term foreign and local currency debt ratings to ‘BB-’ from ‘BB’. The agency maintained a negative outlook.

According to Fitch, both the downgrade and negative outlook reflect high and rising government debt exacerbated by the economic shock triggered by the Covid-19 pandemic.

Further, the country’s very low trend growth and exceptionally high inequality will continue to complicate fiscal consolidation efforts, it said.

Moody’s downgraded South Africa’s long term foreign and local currency debt ratings to ‘Ba2’ from ‘Ba1’. The agency maintained a negative outlook.

According to Moody’s, the downgrade reflects the impact of the pandemic shock, both directly on the debt burden and indirectly by intensifying the country’s economic challenges and the social obstacles to reforms.

Furthermore, South Africa’s capacity to mitigate the shock over the medium term is lower than that of many sovereigns given significant fiscal, economic and social constraints and rising borrowing costs.

Government’s policy priorities remain economic recovery and fiscal consolidation, as outlined in president Cyril Ramaphosa’s Economic Reconstruction and Recovery plan and the Medium-Term Budget Policy Statement released in October, Treasury said.

“The social compact agreed to between government, business, labour and civil society prioritises short-term measures to support the economy, alongside crucial structural economic reforms.”

Simply put, the macro research team at Momentum Investments said that the negative outlook is reflective of larger-than-forecasted deterioration in debt burden and debt affordability, while the chances of  additional financial demands from State owned businesses remains high, as is the potential for higher interest rates.

Moody’s and Fitch’s forecasts:

  • Moody’s expects the SA economy to contract by 6.5% in 2020 (Fitch: negative 7.3%) before recovering by 4.5% (Fitch: 4.8%) in 2021.
  • Moody’s sees the budget deficit expanding to 15.4% of GDP in fiscal year (FY) 2020/2021 (Fitch: 16.3%) before narrowing to 11.8% in FY2021/22.
  • Moody’s expects the government debt ratio to reach 93.3% by FY2021/22 from 70.8% in FY2019/20.
  • Fitch forecasts a rise in government’s debt ratio to 94.8% by FY2022/23.

Momentum Investments said that triggers for further negative ratings action include:

  1. Materially faster rise in SA’s debt burden and further related pressures on debt affordability;
  2. Additional difficulties in implementing growth-enhancing reforms;
  3. Persistent shocks to primary expenditure or revenues;
  4. Sustained rise in the level or volatility of interest rates;
  5. Diminished access to funding at interest rates that would further endanger debt sustainability;
  6. Destabilising large net capital outflow.

Momentum Investments said that a rating upgrade is unlikely in the near future given the negative outlook by Moody’s and Fitch. However, triggers for positive ratings action include:

  1. Efforts to arrest the increase in government’s debt burden;
  2. Confidence in stronger growth prospects;
  3. Labour market or power sector reforms;
  4. Agreement with labour unions on a wage deal that moderates future wage increases.

What does this mean for SA?

Sanisha Packirisamy, an economist at Momentum Investments, said that the downgrade will also have the following implications:

  • Higher borrowing costs for government will crowd out spending on much-needed social and economic programmes;
  • A further knock to business sentiment could lead to lower rates of fixed investment, weaker growth and increased downward pressure on employment;
  • A further negative bias on ratings could lead to a more depreciated currency, higher cost of imported goods, raised inflation and limited extent to which the Reserve Bank can keep monetary policy accommodative;
  • On Moody’s scale, South Africa’s sovereign rating is now in line with Brazil, but above Turkey (B2), on Fitch’s scale, South Africa  ranks in line with Turkey and Brazil;
  • At 234 points, South Africa’s five-year corporate default swap spread (CDS) is 263 points below the April 2020 Covid-19-related peak, it is trading 60 points higher than Brazil’s CDS and 143 points below Turkey’s CDS.

Further Fitch warning

Fitch Ratings said Monday that South Africa may struggle to stick to a plan to rein in government spending by freezing public-sector wages.

Finance minister Tito Mboweni has outlined a plan to pare the government salary bill, which has surged 51% since 2008, as part of an effort to start bringing its debt trajectory down after 2026.

Still, the government hasn’t had a good track record in maintaining a lid on public spending during the past decade, according to Jan Friederich, Fitch’s senior director, sovereign ratings.

South Africa faces the twin challenge of lower growth and rising debt levels, Friederich said on Bloomberg TV. A plan to improve government finances through a public wage freeze, may come unstuck, he said.

“If you look back the past decade, there have always been overruns in wage negotiations even when the offer from the government was quite a bit more generous than inflation,” Friederich said. “Now a wage freeze in an environment where there is still some inflation is quite a drastic measure. A lot of the savings depend on it and its highly uncertain.”

Without state salary cuts, it leaves the government with very little wiggle room, with the central bank unlikely to reduce interest rates any further in the cycle.

The government’s debt projections for the coming years are also deteriorating and should it opt to raise spending to boost growth, that may “exacerbate” the debt challenges, Friederich said.

“The government debt projections for the coming years are much higher than they were, say in spring, and they rely very heavily on the wage negotiations next year,” he said.

Read: South Africa is out of second chances

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6 events that could trigger more downgrades for South Africa