JUNK COUNT­DOWN TO

WHAT HAP­PENS AF­TER A DOWN­GRADE

Finweek English Edition - - FRONT PAGE - By Petri Redel­inghuys

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.

Po­lit­i­cal risk

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

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