DOWNGRADE ALL PRICED IN? THINK AGAIN
While the perception is that markets have priced in a sovereign downgrade, the reality is that South Africa might still pay a hefty price for losing its investment-grade status.
south Africa is still teetering on the brink of losing its investment-grade credit rating for the first time in 17 years, as economic growth falters, investment continues to decline and business confidence remains mired in the doldrums. And despite widespread perceptions that a downgrade to junk status is already priced in by domestic financial markets, many analysts warn there will be a significant impact on the value of domestic shares, bonds, and the rand.
There will also be painful fallout for the business community. “Any company which has links to a global partner will be affected because people will lose confidence in our country and will take finance out,” said Gillian Saunders, the head of advisory services for Grant Thornton South Africa.
“Money coming into the country will be considered extremely high risk and become more expensive. People are holding off on decisions and this would make them even more unlikely to invest cash here – they will look at moving funds and listings offshore,” she added.
Saunders was speaking after Grant Thornton released its International Business Report for the fourth quarter of 2016, which showed that two thirds of South African business executives said their operations and business decisions have been affected by the country’s ‘turbulent economy’ and uncertainty about its future direction.
Nearly half were putting off investment decisions, while nearly a third were considering investing offshore, and 23% were weighing up whether to sell their businesses.
Financial markets may over-react
RMB credit analyst Elena Ilkova said that given the way downgrades have evolved historically in other countries, it was possible that local markets would overreact to a rating downgrade in the short term.
“All asset classes are likely to react initially, although the rand is much more affected by global events and sentiment. The background to such an event would also have to be taken into consideration, in terms of both political and economic developments – local and global,” she added.
The first big hurdle looms in June when both Standard & Poor’s (S&P) and Fitch will reassess their ratings for South Africa, which they have both placed on the lowest rung of the investment grade ladder, together with a negative outlook, which means the next move is likely to be downwards.
Moody’s Investors Service will announce the outcome of a scheduled review early next month, but its decision is not as big a concern as it currently has placed SA two notches above junk status.
But the omens are not good.
On 14 March S&P’s sovereign analyst Gardner Rusike highlighted the threats to the Treasury’s plans to halt rising levels of government debt and bring budget deficits back to below 3% of GDP, an important benchmark.
Growth may not recover
One big risk is that SA’s pace of economic growth will not quicken in line with expectations, which looks possible after figures from Statistics SA earlier this month showed that growth amounted to just 0.3% in 2016 – below expectations and its slowest since the recession in 2009.
If economic output does not expand by more than 1% this year, tax revenues will fall well short of targets for the second year in a row, making it impossible for the government to achieve its debt stabilisation goals.
Another issue is that economic expansion is not keeping pace with population growth, which means that per capita income will continue to fall, keeping the majority of South Africans trapped in poverty and fuelling social instability.
Rusike said that to boost growth the government needed to follow through on planned reforms to ease labour tensions, resolve policy uncertainty, and improve governance at cash-strapped state-owned enterprises (SOEs), which are weighing heavily on official finances.
Political uncertainty is also a red light on the radar screens of investors and rating agencies this year, ahead of a policy conference of the ANC in June and an elective conference to choose a new leader in December.
“If we see a lot of increasing political tensions, in-fighting in state institutions and over political leadership which could derail the government’s plans […] that could impact on our forecasts for growth,” Rusike said.
But his biggest concern was around any unexpected spike in government’s exposure to the liabilities of SOEs, which is already set to climb to R308.3bn in the financial year 2017/18 from R255.8bn in 2016/17. Government guarantees will rise to R477.7bn, which is equivalent to 11.5% of GDP.
“It is a big issue for us that contingent liabilities need to be contained so that they don’t impact negatively on the creditworthiness of the sovereign. The point is that there are pressures on the rating from contingent liabilities,” Rusike said.
Elena Ilkova Credit analyst at RMB Gardner Rusike Sovereign analyst at Standard & Poor’s
Gillian Saunders Head of advisory services at Grant Thornton South Africa