South Africa | Moody’s places South Africa’s Baa2 ratings on review for downgrade

Johannesburg, South Africa, Capital Markets in Africa — New York, Moody’s Investors Service has today placed the Baa2 bond and issuer ratings of the government of South Africa on review for downgrade. Also placed on review for downgrade were South Africa’s (P)Baa2/(P)P-2 shelf and MTN program ratings.

The decision to place the ratings on review was prompted by the continuing rise in risks to the country’s medium-term economic prospects and to its fiscal strength, notwithstanding the tighter fiscal stance undertaken in the 2016/17 budget. The review will allow Moody’s to assess to what extent government policy can stabilize the economy and restore fiscal strength in the face of heightened domestic and international market volatility.

In a related rating action, Moody’s has also placed on review for downgrade the Baa2 rating of the ZAR Sovereign Capital Fund Propriety Limited, which is fully and unconditionally guaranteed by the Republic of South Africa.

Rationale for Initiating the Review for possible downgrade 
Firs driver: To access likelihood that medium-term growth prospects will strengthen
The first driver for the review is to allow Moody’s to assess to the likelihood that the decline in South Africa’s economic strength will be reversed over the medium term. Moody’s cited South Africa’s weak economic performance as a risk factor when assigning a negative outlook to the rating in December 2015. We noted then that the economy was vulnerable to further adverse global, regional, domestic and financial market dynamics, with concomitant negative implications for government revenues, the fiscal balance and the government’s debt burden. Last year’s growth dropped to 1.3%, the slowest pace since the 2009 global financial crisis.

Since then, growth prospects have worsened. Moody’s expects growth to decline still further, to 0.5% in 2016, as a consequence of the intensification of this year’s drought, low commodity prices as well as the volatility in global and domestic financial markets since December, resulting in a further steep depreciation of the exchange rate and widening bond yields. The drought has necessitated imports of key grain crops and pushed up food prices and overall inflation rates, leading to interest rate rises which have further undermined growth. This has also led the government to reallocate spending from other areas to provide drought relief.

During the review, Moody’s will assess the likely effectiveness of the government’s plans, including those contained in the National Development Plan, to address structural constraints on a more inclusive growth through improvements in infrastructure. The rating agency will also use the review period to examine whether recent reforms, such as the amendment to the Labor Relations Act last year, are likely to reduce work stoppages from strikes as the end of various key wage agreements approaches and thereby potentially improve how business views the labor market environment in South Africa.

Second driver — To access the likelihood of stabilization and restoration of fiscal straighten 
The second driver of the review is to allow Moody’s to assess whether government policy is likely to lead to a reversal in the continuing erosion of the government’s balance sheet. Over the last several years, South Africa has experienced a series of external shocks and adverse domestic developments (including lower than forecast growth, but also large public sector wage hikes) that have progressively weakened the government’s balance sheet.

The worsening debt dynamic was another factor Moody’s noted when assigning a negative outlook to the rating in December 2015. As with growth, the debt position has continued to deteriorate, even if only slightly. Despite the government’s adherence to expenditure ceilings in recent years, adverse growth and revenue dynamics have resulted in debt to GDP (excluding guarantees) increasing to 50% of GDP this fiscal year from a trough of 26.5% in March 2009. The deterioration in key fiscal and debt metrics has rendered the country’s public finances increasingly vulnerable to negative shocks.

During the review, Moody’s will examine the likelihood of the recently announced 2016/17 budget and medium term expenditure framework being implemented as intended, and achieving the stated objective of consolidating the public finances and reversing the deterioration in fiscal strength witnessed in recent years. The ratings agency will explore the implications of expensive schemes, such as nuclear energy and National Health Insurance, for the government’s finances in an environment of rising interest rates. It will also assess the implications for policy of the prolonged lull in growth, persistent spending pressures and political drivers such as the upcoming local elections.

What could change the rating  — Down 
Moody’s could downgrade the rating if the review were to conclude that government policy and strategy is unlikely to lead to a reversal in the debt trajectory. Evidence of further shocks to growth and/or lower confidence in policymakers’ commitment to fiscal restraint could lead to a downgrade. Further deterioration in the investment climate would also place downward pressure on the rating if it undermined medium-term growth prospects and/or the availability of external financing for the current account deficit. More generally, indications that the slowdown in growth will be even deeper and more protracted than currently expected would be negative for the rating.

What could lead to confirmation of the rating at the current level 
Moody’s would confirm the rating at Baa2 if the review were to conclude that policymakers will maintain spending restraint, succeed in the delivery of planned structural reforms, achieve the fiscal consolidation envisioned in the 2016/17 Budget Review, and thereby reverse the deterioration in key credit metrics witnessed in the past few years.