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South African Downgrade Delayed, Not Avoided

South African Downgrade Delayed, Not Avoided
South African Downgrade Delayed not Avoided

While credit ratings agencies hold their outlook on South Africa’s debt steady for now, further economic and political shocks will make a downgrade to sub-investment grade near inevitable by late 2016 or early 2017.

On 3 June, credit ratings agency Standard & Poor’s maintained its negative outlook on South Africa’s BBB- rating, yet warned that a downgrade of the country’s sovereign debt to non-investment grade or so-called ‘junk’ status could still occur later in 2016 or 2017. Both Standard & Poor’s and Fitch had already downgraded the country’s debt to one level above non-investment grade. Ratings agency Moody’s maintained its Baa2 rating in May, while Fitch is due to make its review public over the next week.

The ratings agencies steady decisions have been due to Finance Minister Pravin Gordhan’s investor roadshow in March to the US and UK. The roadshow was aimed at restoring confidence in South Africa’s economy after President Jacob Zuma unilaterally dismissed former finance minister Nhanhla Nene in December 2015 and appointed a loyal back-bencher to replace him. The unexpected and abrupt nature of the announcement caused the rand to plummet to a new low of R16.00 to the US dollar and rattled stock markets, with some banking stocks falling 20% in two days. As a result of the widespread backlash, Zuma was forced to make a humiliating about-turn and reappointed the respected Pravin Gordhan. Following his appointment, Gordhan has sought to reassure ratings agencies and investors of the government’s commitment to stabilize public debt at below 50% of national output.

Since then, the agencies’ major concerns are unsustainable public spending, mismanagement and overspending at state-owned enterprises, rising unemployment, lackluster growth (at most 0.9% in 2016), lack of regulatory clarity on key legislation such as minerals development and labor practices, as well as the uncertain political climate ahead of the 2017 ANC elective congress and the 2019 national elections. Moreover, there has been speculation in South African media that Gordhan could face arrest based on politically motivated charges, which has further rattled investor nerves.

Indeed, Standard & Poor’s could still place South Africa on credit watch, which would indicate a near certain downgrade. The impact on the country’s economy would be devastating, drying up foreign investment, raising borrowing costs, while major international investors would be forced to ‘dump’ the country’s debt. According to Gordhan, it could take five years for South Africa to retain investment-grade status following further downgrades. A cut to non-investment grade would increase South Africa’s borrowing costs and further frustrate attempts to plug a budget deficit estimated at 3.2% of GDP in the 2016/17 financial year.

Risk implications: The prospect of a further credit downgrade has been delayed, but not avoided. The key indicators for a downgrade are future policy mistakes, a lackluster economy, lack of necessary reforms, and an uncertain political outlook. EXX Africa still believes that a downgrade by at least one credit ratings agency in 2016 or 2017 is almost inevitable, unless serious political change is triggered by the August municipal elections. The most likely timeline for a credit downgrade is in December or early 2017.

This holds serious implications for the local banking sector. South African banks have been hit hard by the shock to the rand and financial markets, while already facing an increasingly vulnerable economy and the increasingly likely prospect of a credit downgrade to junk status by ratings agencies. Meanwhile, aggressive rate hikes by the reserve bank would further damage local banks given their exposure to household debt. However, local investors are unlikely to turn away from South African banks, which have proven resilient to exogenous shocks over the past few years, thus limiting any immediate liquidity risks in the sector.

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Robert Besseling is the founder and executive director of EXX AFRICA, a specialist intelligence company that reports on African political and economic risk to businesses. He holds an MA (Hons.) in History from the University of St. Andrews in Scotland. He also has an MBA and a PhD in African political and economic history.

Visit Frontera’s Research and Intelligence Marketplace for more of EXX AFRICA’s reporting on political and economic risk throughout sub-Saharan Africa.

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