Leon Myburgh, head of the financial markets department at the South African Reserve Bank, says that while the recent opinions from rating agencies were ‘somewhat’ positive, the country is not yet out of the woods.
Speaking at the Council of Retirement Funds for South Africa/Batseta’s Winter Conference in Durban, Myburgh provided an historical overview of South Africa’s relationship with credit rating agencies.
On 6 May, Moody’s affirmed the country’s foreign-currency credit rating at Baa2 with a negative outlook. This, after Moody’s put South Africa on review for a possible downgrade.
“Moody’s affirmation of the rating, despite having put the country on review, was a very positive development and surprised financial markets as a rating review usually leads to a ratings action,” Myburgh said.
South Africa also has a negative outlook from Standard and Poor’s (S&P), mainly as a result of a significant downward revision to its growth forecast for the country.
Following its most recent review, S&P affirmed South Africa’s BBB- rating though they have maintained the negative outlook.
“As neither of these agencies downgraded South Africa, it indicates that they are waiting to see the effect of the recent measures introduced by the authorities and the private sector.
“However, as both Moody’s and S&P have maintained the negative outlook, we are not out of the woods yet and there is no room for complacency,” Myburgh said.
The evolution of South Africa’s credit rating
South Africa attained its first formal credit assessment in 1994, and today, despite recent downgrades, the country still enjoys an investment-grade foreign currency debt rating from four ratings agencies.
S&P and Fitch’s rating are one notch above non investment grade (BBB-), Moody’s rates South Africa at Baa2, two notches above non-investment grade, while we have a rating of BBB+ from Rating and Investment (R&I), three notches above non-investment grade.
The initial upward trajectory of these ratings started soon after the first democratic elections in South Africa, Myburgh noted.
From the bottom of the investment-grade band by Moody’s (Baa3) and non-investment grades from S&P and Fitch (BB), the country’s sovereign rating by Moody’s improved to A3 in July 2009, which, at current ratings, is similar to countries such as Ireland, Malaysia and Peru, the Sarb’s analyst said.
The peak in the ratings from S&P and Fitch was achieved in 2005 at BBB+, and one notch higher at A-by R&I in 2006. These ratings were respectively four (Moody’s and R&I) and three notches (S&P and Fitch) above non-investment grade.
The improved creditworthiness of South Africa reflected a sound economic landscape, Myburgh said.
This included the narrowing of the current-account deficit since the mid-1990s to a small surplus in 2002, while economic growth improved from a small contraction in 1998 to an annualised growth rate of slightly more than 7% in the second quarter of 2005.
The country’s ratio of government debt to gross domestic product (GDP) improved from around 50% in 1995 to almost 25% prior to the global financial crisis (GFC).
“The favourable economic backdrop and concomitant improved credit ratings lured foreign investors to South Africa’s domestic financial markets. In the ten years prior to the GFC, non-residents bought a cumulative amount of almost R400 billion worth of domestic equities and just over R100 billion worth of bonds,” Myburgh said.
He noted that the equity market rallied by almost 500% over the same period while the ten-year government bond yield declined by about 800 basis points to around 7% in 2005 and 2006.
Key factors influencing sovereign ratings
The first factor, according to the Reserve Bank, is economic strength, “which reflects a country’s intrinsicability to honour its debt obligations and deal with various exogenous shocks”.
Economic growth metrics are a concern for SA, not only for authorities, but also for the rating agencies.
The Reserve Bank’s GDP growth forecast for 2016 has been revised down from 0.8% to 0.6%. While a recovery is still expected in the next two years, the forecasts for both these years were revised down by 0.1 percentage points to 1.3% in 2017 and 1.7% in 2018.
The second aspect of ratings is institutional strength, “which is a key consideration for foreign investors who are considering investing in a country, though this does also affect local investor confidence,” said Myburgh.
“South Africa generally does quite well in this regard. For example, the national budget process is highly transparent and respected globally, and the judicial system is seen as strong and independent.”
The third factor is fiscal strength, “which is primarily an assessment of the overall health of government finances. Governments which have a short debt maturity profile face significant refinancing risk,” the bank said.
In South Africa’s case, the weighted term-to-maturity of total government debt is 12.7 years, and National Treasury actively manages various risks associated with its debt portfolio, Myburgh said.
South Africa’s government gross debt to GDP ratio is expected to remain between 50 and 51% over the medium term. And while in line with the emerging-market average, it is better than Brazil (76-81%) and India (around 66%).
“It is also noteworthy that only 10% of South African government debt is denominated in foreign currency, reducing the exposure to exchange rate shocks. In addition, short-term debt is sufficiently covered by reserves,” Myburgh said.
Susceptibility to event risk is also important for rating agencies. “This criterion assesses whether sudden events or risks could materially increase the probability of default,” the analyst said.
South Africa’s financial markets are also highly advanced, have good liquidity and a strong domestic investor base. “However, the country’s dependence on foreign portfolio financing to fund the current-account deficit makes it somewhat vulnerable to exogenous financial sector shocks.”
“The recent pronouncements by Moody’s and S&P have given us a window of opportunity to prevent more rating downgrades. However, the negative outlook indicates that we must remain focused and take appropriate and decisive action,” Myburgh said.