Moody’s keeps South Africa above junk for now – with a negative outlook

Moody’s Investors Service has changed the outlook on South Africa’s credit ratings to negative from stable – but has for now affirmed the Baa3 long-term foreign-currency and local-currency issuer ratings.

Moody’s decision to change the outlook reflects the ‘material risk that the government will not succeed in arresting the deterioration of its finances through a revival in economic growth and fiscal consolidation measures’, the group said in a statement on Friday.

“The challenges the government faces are evident in the continued deterioration in South Africa’s trend in growth and public debt burden, despite ongoing policy responses,” it said.

“While high unemployment, income inequality and the social and political challenges they imply for policymakers are long-standing features in South Africa, the obstacles that they pose to the government’s plans to raise potential growth and contain fiscal deficits are proving more severe than expected a year ago.

“Acute financial stress for state-owned enterprises (SOEs), in particular Eskom, continues to require sizeable ongoing support from the government.

“The development of a credible fiscal strategy to contain the rise in debt, including in the 2020 budget process and statement, will be crucial to sustain the rating at its current level,” it said.

The Baa3 rating affirmation takes into account the country’s deep, stable financial sector and robust macroeconomic policy framework, set against ongoing challenges related to weak potential growth and strong fiscal pressures.

Heading for a debt trap

Moody’s added that South Africa is on a debt-trap trajectory.

“In the last two years, it has become increasingly apparent that those constraints are challenging the government’s ability to implement reforms that would durably lift growth, to an even greater extent than previously expected.

“Moody’s has revised down its medium-term growth projections to 1-1.5%, barely in line with population growth, from earlier expectations of a gradual pick-up towards 2.5-3%,” it said.

Job creation remains a central problem, with unemployment at a multi-year high of 29% in the third quarter of 2019.

Gross fixed capital formation has been contracting on a year-on-year basis since the second quarter of 2018, as private companies see limited prospects of an improvement in the business environment.

“The government has promoted a number of initiatives in response to these long-diagnosed issues.

“However, its ability to implement those initiatives in a way which generates broadly-based sustainable growth has faced obstacles in part from outstanding vested interests, in part from the social and political challenge of imposing measures that are initially likely to be detrimental for parts of the population,” the firm said.

“Low growth is exacerbating the pressures on South Africa’s fiscal position. The government debt burden has risen further than was expected a year ago and will rise still more in the coming years.”

What could make the rating go up

A rating upgrade is very unlikely in the near future, Moody’s said.

Moody’s said it would likely change the rating outlook to stable if it were to conclude that the government will succeed in stabilising its debt ratios over the medium term, by reining in expenditures, improving tax compliance and by lifting potential growth.

The ratings agency said it will have regard to a number of factors in this respect, including the government’s progress early on in its tenure in delivering the additional fiscal adjustments which the MTBPS identifies are needed, but also in addressing long-standing issues related to corruption and the financially weak SOEs sector, and in particular at Eskom.

“If achieved, these should ultimately enhance business confidence and private sector investment prospects,” it said.

What could make the rating go down

South Africa’s ratings would likely be downgraded were Moody’s to conclude that those conditions will not be met and that South Africa’s fiscal and/or economic strength will continue to erode.

Ultimately, this conclusion would likely reflect diminishing prospects that growth will be sufficient to preserve current income levels for the majority and halt the rise in government debt over the medium term.

Signs of diminishing resilience to external financing shocks would also exert downwards pressure on the rating, it said.

“More immediately, a decision to downgrade the rating would reflect growing clarity that the government will not be able to further develop and implement its fiscal and economic strategy to halt and ultimately reverse the debt trajectory,” Moody’s said.

“The 2020 budget in particular will be a key indication in Moody’s view of whether or not the government is committed to the fiscal consolidation recommended by the MTBPS.”

Read: The Moody’s mystery: how has South Africa not been junked yet?