STILL PROBLEMS, BUT . . .
The good news is that Fitch and S&P didn’t downgrade SA again; and the really good news is that they think SA will avoid a hard landing — for now
Reading between the lines of SA’S latest credit rating reviews, there is some positive news: neither Fitch nor S&P is expecting the country to experience significant fiscal slippage or a year of negative growth over the medium term.
And though the growth rate is likely to remain sluggish, neither agency is expecting SA to suffer a hard landing unless the ANC tacks left towards more populist policies.
Both agencies flag the risk that economic policy could be swayed, either by the internal ANC factional battles that will play out between now and the 2019 election or by societal demands for economic emancipation. But it is not their central view that the ANC will ditch its current economic policy framework.
Their base case is that SA will avoid populist solutions, stick to the expenditure ceiling, experience a gradual growth recovery (helped by cyclical factors), and escape with some moderate fiscal slippage.
State-owned enterprises (SOES) pose the biggest risk to this view, however, with both agencies stressing just how serious a risk their continued financial deterioration poses to SA’S fiscal stability.
Operational inefficiencies, poor procurement practices, and the failure to abide by fiduciary obligations, some of which occurred while finance minister Malusi Gigaba was public enterprises minister from 2009 to 2014, have plunged several SOES into financial difficulty.
Nevertheless, Fitch and S&P have adopted the consensus economic view on SA: that it is going to avoid making a historic mistake that causes government debt to explode and growth to fall off a cliff. So as long as the consensus scenario plays out, SA is unlikely to be downgraded further by Fitch and S&P in the short term.
SA’S ratings with S&P are split. SA’S local-currency debt is ranked BBB- on the bottom rung of investment grade
What it means: Gigaba has little wiggle room, but net debt should stabilise at 50% of GDP
Government’s top priority should be to rebuild business and investor confidence to lift the economy onto a structurally higher growth path Rian le Roux
and its foreign-currency debt at the top of the junk ladder, at BB+. All SA’S ratings with Fitch are BB+.
The worry is that while Fitch has SA on a “stable outlook”, S&P has retained its “negative” outlook, which suggests SA’S localcurrency rating remains vulnerable to being junked.
S&P’S “negative” outlook reflects its view that political risk will remain “elevated” this year.
“This could distract from growth-enhancing reform, slow the pace of fiscal consolidation, and weigh on investor and consumer confidence,” it says in its ratings statement.
It would consider lowering SA’S ratings if the country’s fiscal and macroeconomic performance deteriorates substantially from its baseline forecasts. These don’t allow for much fiscal slippage so Gigaba will have to keep a tight rein on spending.
S&P expects SA’S growth recovery to be more gradual than treasury expects, with real GDP getting back up to 2% of GDP only by 2020 — two years later than treasury’s forecast. But it still expects the budget deficit to decline in line with treasury’s estimates, slowing from 3.4% now to 2.8% of GDP by 2019.
S&P believes net government debt will stabilise at 50% of GDP by 2019, as opposed to treasury’s target of 48% by 2019/2020. This is the full extent of the breathing room S&P has allowed.
Fitch expects Gigaba to stick to SA’S spending ceilings, but because it feels trea- sury’s growth and tax buoyancy assumptions are too optimistic, the budget deficit is likely to remain “sticky” at around 3% of GDP.
“As the new finance minister has emphasised, government’s commitment to existing fiscal targets still stands,” says Fitch.
“As a result, it is unlikely government will raise its expenditure ceilings, which have served as a key anchor for fiscal policy.”
Fitch expects Gigaba to announce some expenditure cuts in his medium-term budget policy statement in October, but for these to be too small to fully offset the likely tax shortfall. As a result, it expects a budget deficit of 3.3% in 2017/2018 and 3.1% in 2018/2019 versus treasury’s targets of 3.1% and 2.8% respectively.
For Fitch, a marked increase in the debtto-gdp ratio or in contingent liabilities; steeply rising net external debt; and a further deterioration in trend GDP growth could, individually or collectively, result in a negative rating action.
Both agencies consider SOES with weak balance sheets to be among the biggest risks to the debt outlook.
The sector has drawn down 65% of its total available pool of R478bn in government guarantees, up from 55% a year ago. The International Monetary Fund (IMF) estimated that should 75% of government’s guarantee exposure be realised, it would push state debt above 70% of GDP by 2021. This is the “highrisk threshold” often associated with debt distress in other emerging market countries.
Given the combination in SA of low growth, relatively high interest rates and the outlook for the primary balance, the IMF suggested some years ago that SA’S maximum, sustainable debt ceiling was around 50% of GDP.
This figure has become a red line engraved in the institutional memory of treasury. If treasury bleeds experienced staff under Gigaba (as the SA Revenue Service has done under commissioner Tom Moyane), or if Gigaba fails to operate inside this red line, SA’S fiscal position could become increasingly unsustainable.
Fitch reveals the shocking statistic that not only do government’s guarantees to SOES, independent power producer contracts and public-private partnerships amount to 10% of GDP, but SOES’ unguaranteed debt constitutes another 10.5% of
GDP, taking the total to almost R1 trillion.
“Given the weak state of SOE finances, the problems in SOE governance and the importance of SOES for the country’s economy and politics, the risk that some of this debt will land on the [country’s] balance
is substantial,” it concludes.
S&P estimates the SOE sector will probably need almost R200bn more in extraordinary government support over the next three years. And it doesn’t believe reforms to this sector will be implemented any time soon.
It singles out Eskom, noting that “plans to improve Eskom’s underlying financial position may not be implemented in a comprehensive and timely manner, as it is still addressing its governance issues.” Eskom still has to complete its board appointments and appoint a permanent CEO.
Moody’s is expected to announce its ratings action at any moment, but given that it has historically taken a more generous view of SA, the expectation is that it will cut both SA’S local- and foreign-currency ratings by just one notch. This would keep them investment-grade, albeit on the lowest rung of the category, just one notch above junk status.
As long as SA retains its investmentgrade local-currency rating with Moody’s and S&P, it will be able to remain in the World Government Bond Index (WGBI). If not, many large investment funds would be forced to divest their SA government bond holdings — which could result in capital outflows of up to R150bn, by some estimates.
This could lead to a full-blown rand crisis and deep recession, from which it could take many years to recover.
Old Mutual Investment’s chief economist Rian le Roux believes the biggest economic threat facing SA over the medium term is moderate stagflation (sustained weak economic growth amid sustained relatively elevated inflation).
“Such an outcome will likely intensify fiscal, social and financial pressures and result in SA eventually losing its investment-grade status by all agencies and on all classes of bonds,” he warns. “So, while the S&P reprieve is very welcome, SA has lots of work to do to fundamentally change course in order to get the economy on a higher-growth path.”
Government’s top priority should be to rebuild business and investor confidence to lift the economy onto a structurally higher growth path, he feels. To do this it has to clarify the practical policy implications of government’s “radical economic transformation” agenda.
Responding to the rating actions, Gigaba said “radical socioeconomic transformation” did not imply a fundamental policy shift. Treasury’s key focus was to “safeguard confidence and reclaim the investment grade ratings,” he added, acknowledging that for this to occur, sustainable fiscal policy and efforts to tackle the sources of low growth would be critical.