JUNK COUNTDOWN TO
WHAT HAPPENS AFTER A DOWNGRADE
tis the eve of 9 December in the 21st year after the end of apartheid and the president of South Africa is midway through an aimless 55-minute speech about Pan-Africanism at an exclusive black-tie event attended by the leaders of no less than 10 other nations on the African continent, and the South African rand is plummeting. Fast.
The Presidency has just issued a statement to say that the much-respected finance minister Nhlanhla Nene has been relieved of his duties and replaced with the unknown Des van Rooyen. By the time afternoon comes around on 10 December 2015, hundreds of billions of rands’ worth of value has evaporated from banking shares (the prices of which dropped more than 20%) and other financial institutions’ market capitalisations. The rand has plummeted to new record lows of nearly R16 against the dollar. (Little did we know what was still to come: on 11 January, it would touch on R17.99 against the dollar in early Asian trade after Zuma defended his decision to fire Nene, saying the market reaction was exaggerated.) It appears that the country had just been thrown back into the dark ages.
Influential leaders in the spheres of business, religion and civil society rise up, speak out and take action. Emergency meetings are called and after the sun has risen and set another three times, Des van Rooyen is replaced by Nene’s predecessor, the revered Pravin Gordhan. The game of
The faith of the international investing community has been lost. SA will mourn these events for a long time to come. Politics has interfered with the markets.
ministerial musical chairs has ended and the country has peered over – but thankfully not crossed – the edge of catastrophe.
The foray has come to an end as abruptly as it started – but not without claiming numerous victims. Individual investors have been decimated – the Public Investment Corporation, which manages investments on behalf of the Government Employees Pension Fund (GEPF), among others, lost R99bn in the 48 hours after Nenegate. Though Nenegate has not been the only factor, the rand was trading 29% weaker against the dollar than a year ago. The prime overdraft rate has increased by 1.25 percentage points to 10.5%. The faith of the international investing community has been lost. SA will mourn these events for a long time to come. Politics has interfered with the markets.
Gordhan versus Zuma
Since the highly controversial events of Nenegate, an ongoing saga has unfolded within the South African political landscape. The president has managed to survive a Constitutional Court ruling that found he breached his oath of office, an attempted vote of no confidence in Parliament, and a High Court ruling that 783 charges of corruption, fraud and racketeering should be reinstated against him. (Both Zuma and the National Prosecuting Authority said on 23 May that they would appeal the High Court ruling.)
Despite the lessons from Nenegate, there has been no attempt from the Presidency to publicly express confidence in, and support for, Gordhan. The finance minister’s job seems insecure, with ongoing rumours about his possible arrest related to the special investigations unit that was set up during his time as the Commissioner of the South African Revenue Service (Sars).
With the often-public battles between the Zuma and Gordhan camps – also known as the tenderpreneur and antitenderpreneur camps – continuing, the market has been swinging back and forth like a pendulum as the sentiment of the international and local investment community regarding the political stability of SA keeps changing.
The graph on the next page indicates to us the severe reaction the rand has had to the events of Nenegate and the reports of Gordhan’s possible arrest, which would pave the way for Zuma to fire him.
It could get worse, warns Peter Attard Montalto, London-based economist at
Japanese investment bank Nomura.
Montalto said in a recent note to clients that Zuma is “hunting for any route to remove Gordhan, which should be hard but not impossible. We think the market is still grossly underestimating political risk premia, and President Jacob Zuma’s present position and power – he is not a lame duck and may discount market turbulence.”
Despite the pressure, which has led to Gordhan’s unprecedented appeal to the public to “protect” the National Treasury staff, he has (so far, at least) stood his ground on two of the key issues that were seen to be contributing to Nene’s downfall: resisting a bailout of South African Airways (SAA) and giving the green light for the nuclear build programme to go ahead. Serious concerns remain over the affordability of the latter. SAA, which is chaired by Zuma’s close confidante
Dudu Myeni, requires Treasury to extend new government guarantees to continue operating as a going concern, something Gordhan has refused to do until Myeni is removed and the board reshuffled.
However, Zuma now seemingly has the upper hand in the battle at Sars, where Gordhan ordered new Commissioner Tom
Moyane to halt a pricey restructuring. It seems the restructuring is going ahead, with Moyane telling Parliament on 17 May that it was already approved by Nene in August 2015.
Gordhan’s support will also be illustrated by the extent to which ministers co-operate with Treasury investigations and findings on tenders. The first litmus test will be whether the department of correctional services cancels a controversial R378m tender awarded to Integritron Integrated Solutions (IIS), as ordered by Treasury following an investigation by Treasury’s chief procurement officer (CPO).
The Treasury investigation found that IIS was irregularly appointed on a number of grounds, including that it didn’t have the capacity and ability to execute the contract, that a fronting relationship exists between the main contractor and the sub-contractor and that a false declaration was made by the bidder. Gordhan accordingly advised correctional services minister Michael Masutha to cancel the contract, restrict IIS and its associates from doing business with government, and investigate disciplinary charges against members of the bid committee and the accounting officer.
So far, there has been no cancellation. Masutha told Parliament in May that the department is busy auditing the contract, and that it is also the subject of a court case. The Sasstec group of companies, of which IIS forms part, wanted to interdict Gordhan, Masutha and Solly Tshitangano, chief director for governance, monitoring and compliance at the CPO’s office, from implementing Gordhan’s instructions in the letter, News24 reported.
Two key dates the markets will be focusing on are 3 June, when Standard & Poor’s (S&P) will announce the outcome of its latest ratings review of SA’s sovereign debt, and 3 August, when South Africans will vote in local government elections. Assuming that the local elections will do little to change the current status quo, we must try to understand the impact that the current political turmoil has had, and will continue to have, on our economy.
After all, our fate as an international investment destination now lies in the hands of the credit ratings agencies, particularly S&P, whose current rating of
S&P is set to announce its decision on South Africa’s credit rating on 3 June. The ratings agencies have mentioned, more than once, that one of SA’s biggest threats is political instability, and with a president who seems hell-bent on staying in office at any cost, it seems unlikely that one could consider SA to be politically stable.
SA’s debt is just one notch above junk. (Fitch is also due to release a ratings decision on SA in June. It currently rates the country one notch above junk, with a stable outlook.) Therefore we must try to understand our own situation from their perspective. So what are they watching?
From a political risk perspective, the Zuma/Gordhan battle, and the possibility of Gordhan getting fired, will remain a red flag. The ratings agencies have mentioned, more than once, that one of South Africa's biggest threats is political instability, and with a president who seems hell-bent on staying in office at any cost, it seems unlikely that one could consider SA to be politically stable.
The local government elections will show whether Nenegate and the Constitutional Court judgment against Zuma, along with the allegations of “state capture” related to the Gupta family, have dented support for the ANC. The elections will be a litmus test as to whether and by how much these developments are eroding support of the ruling party, and of the consequences for the robustness and clarity of economic and fiscal policy, Moody’s said in its recent review of SA’s credit ratings, published early in May.
Another factor to consider is that of social unrest. Last year SA experienced
an uprising amongst students over university fees that resulted in a series of increasingly violent protests and damage to university facilities. The remnants of the #FeesMustFall movement, and its spin-off #omf (Outsourcing Must Fall) campaign, are still reverberating through universities today, illustrated by incidences of arson and property damage at a number of universities throughout the country over the last few months. The youth of SA are unhappy with the progress since the end of apartheid and understandably believe that by now more could have been achieved. If something is not done to address their grievances, it is difficult to see a de-escalation in their destructive activities.
Civil servants, too, are not happy with the current state of affairs and are taking to the streets to literally litter their opinion, as illustrated by the recent lengthy Pikitup strike in Johannesburg. Their issue is wages, a common theme for social unrest in SA in the private sector as well. The people demand better living conditions and higher wages although the state, and the companies that often fall victim to similar protests, cannot afford to keep increasing the wages of those most affected by SA’s rampant food inflation as the country’s economy is simply not growing fast enough to support higher wages.
This in itself is a tragedy. The South African government stands accused of grand larceny while the economy and the lives of ordinary people are deteriorating, although those in the upper echelons of power enjoy lives of opulence. Inequality reigns supreme and there will only be more social unrest unless the status quo is decisively addressed.
On the plus side, Moody’s said in its May review that it remains confident in the country’s institutional strength, which it sees as high, notwithstanding recent corruption scandals. Moody’s also said that SA’s monetary and fiscal institutions have proven to be sound over time.
The state of the economy
While confidence in the strength of SA’s
institutions to weather the political storms will be crucial to keep further downgrades at bay, ultimately it is the state of the country and government’s finances that will determine the likelihood and timing of a downgrade to junk.
Uncertainty over a possible junk rating has cast a shadow over local markets – it remains to be seen to what extent a downgrade has already priced into the market. Should S&P assign a junk rating in June, many funds would be forced to sell off South African assets and bonds and our market would suffer severely. Goolam Ballim, chief economist of Standard Bank, said on 23 May that a downgrade would lead to negative GDP growth of -0.3% this year and at least 200 000 job losses. (See sidebar on p. 30.)
One factor the ratings agencies would consider is the outlook for economic growth. Statistics SA reported on 23 May that it had to revise its estimate for real GDP growth in the fourth quarter of 2015 downwards from 0.6% quarter-on-quarter to 0.4% quarteron-quarter. It kept its estimate for 2015 unchanged at 1.3%, making it the slowest annual expansion since the 2009 recession, according to NKC African Economics.
Why does this matter? The “downward revision of real GDP growth in Q4 provides further evidence of the economic quagmire SA is facing, with low expansion rates contributing to the private sector’s poor business confidence and low job creation. Looking ahead, economic performance, or the lack thereof, in the first quarter of 2016 will be a key factor in ratings agencies’ analyses,” NKC African Economics said in a note to clients.
Moody’s has been slightly more optimistic, saying in its May review that it expects economic growth to “gradually strengthen after reaching a trough this year, as the various supply-side shocks that have suppressed economic activity
since 2014 recede”. Electricity supply is now more reliable, the drought is ending and the number of workdays lost to strikes has shrunk significantly, Moody’s said. The inflation outlook is also more subdued now, which could lead to less steep interest rate hikes than was anticipated earlier this year, offering some relief to household finances. The market consensus is for a further 50 basispoint increase over the remainder of the year.
Another factor is the state of government’s finances. Moody’s said in its May report, when it maintained its credit rating at two notches above junk with a negative outlook, that it expects government debt ratios to stabilise in the current financial year at around the current level of 51%. Positives highlighted by Moody’s included government’s pledge to achieve a budget surplus in the 2017/18 financial year; its track record of achieving fiscal targets; and the budget’s high degree of flexibility.
It is easy to blame the historical, current and ongoing political situations for the poor performance of the South African financial markets over the past two years. But there are macro factors at play as well, and even though it may sound as if a dead horse is being beaten, China’s slowing economy is taking its toll on emerging markets. The fact is that the general South African equity market has not had any real growth for the last two years due more to major global economic challenges.
I would argue that thus far the political turmoil has had a muted impact on our market on the whole, although the chickens are about to come home to roost. The major risk now is that SA is downgraded by the ratings agencies and that international investment funds flow out of our economy. If this happens, then I believe we can lay the blame at the feet of politics.
Positives highlighted by Moody’s included government’s pledge to achieve a budget surplus in the 2017/18 financial year; its track record of achieving fiscal targets; and the budget’s high degree of flexibility.
Nhlanhla Nene Former minister of finance
President Jacob Zuma and the finance minister, Pravin Gordhan, during a meeting with cabinet ministers and business leaders on 9 May in Pretoria.
Atul Gupta One of the controversial Gupta brothers