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South Africa sank deeper into junk territory last week after Moody’s Investors Service teamed up with Fitch Ratings to downgrade the country’s credit ratings.
Moody’s downgraded both ratings to Baa2 and maintained a negative outlook due to an expected further weakening in SA’s fiscal strength.
Fitch downgraded both ratings to BB- and maintained a negative outlook to reflect high and rising debt, a very low growth trend and extreme inequality.
Standard and Poor’s Global Ratings (S&P) on Friday maintained its assessment of South Africa’s foreign currency debt three notches below investment grade, with a stable outlook.
Reasons for the rating decision:
Fitch downgraded South Africa’s long-term local and foreign currency debt ratings to ‘BB-‘ from ‘BB’. The agency maintained a negative outlook.
According to Fitch, both the downgrade and the negative outlook reflect a high and growing public debt compounded by the economic impact caused by the Covid-19 pandemic.
Additionally, the country’s very low growth trend and exceptionally high inequality will continue to complicate fiscal consolidation efforts, he said.
Moody’s downgraded South Africa’s long-term local and foreign currency debt ratings to ‘Ba2’ from ‘Ba1’. The agency maintained a negative outlook.
According to Moody’s, the reduction reflects the impact of the pandemic shock, both directly on the debt burden and indirectly by intensifying the country’s economic challenges and social obstacles to reforms.
Furthermore, South Africa’s ability to mitigate the impact in the medium term is less than that of many sovereign countries given significant fiscal, economic and social constraints and rising borrowing costs.
The government’s policy priorities remain economic recovery and fiscal consolidation, as outlined in President Cyril Ramaphosa’s economic recovery and reconstruction plan and in the Medium-Term Budget Policy Statement released in October, the Treasury said.
“The social pact agreed between the government, companies, workers and civil society prioritizes short-term measures to support the economy, along with crucial structural economic reforms.”
In a nutshell, Momentum Investments’ macro research team said the negative outlook reflects a greater-than-anticipated deterioration in debt burden and debt affordability, while the potential for additional financial demands from SOEs remains. high, as is the potential for higher interest rates.
Moody’s and Fitch’s Forecasts:
- Moody’s expects the South African economy to contract 6.5% in 2020 (Fitch: negative 7.3%) before recovering 4.5% (Fitch: 4.8%) in 2021.
- Moody’s expects the budget deficit to expand to 15.4% of GDP in fiscal year (FY) 2020/2021 (Fitch: 16.3%) before narrowing to 11.8% in FY2021 / 22.
- Moody’s expects the public debt ratio to reach 93.3% for fiscal 2021/22 from 70.8% for fiscal 2019/20.
- Fitch forecasts an increase in the government debt ratio to 94.8% for fiscal 2022/23.
Momentum Investments said triggers for new negative-rated stocks include:
- Materially faster rise in SA’s debt burden and other related pressures on debt affordability
- Additional difficulties in implementing growth-friendly reforms;
- Persistent shocks in primary income or expenses;
- Sustained increase in the level or volatility of interest rates;
- Decreased access to financing at interest rates that would further jeopardize debt sustainability;
- Destabilization of large net capital outflows.
Momentum Investments said a rating upgrade is unlikely in the near future given the negative outlook from Moody’s and Fitch. But nevertheless, Positive ratings action triggers include:
- Efforts to halt the rise in the government debt burden;
- Confidence in stronger growth prospects;
- Reforms of the labor market or the electricity sector;
- Agreement with unions on a wage agreement that will moderate future wage increases.
What does this mean for SA?
Sanisha Packirisamy, an economist at Momentum Investments, said the downgrade will also have the following implications:
- Higher borrowing costs for the government will crowd out spending on much-needed social and economic programs;
- A further blow to business sentiment could lead to lower fixed investment rates, weaker growth and greater downward pressure on employment;
- An additional negative bias in the ratings could lead to a more depreciated currency, higher cost of imported goods, high inflation and limited degree to which the Reserve Bank can maintain accommodative monetary policy;
- On Moody’s scale, South Africa’s sovereign rating is now in line with Brazil’s, but above Turkey (B2), on the Fitch scale, South Africa ranks in line with Turkey and Brazil;
- At 234 points, South Africa’s five-year corporate default swap spread (CDS) is 263 points below the Covid-19-related peak of April 2020, it is trading 60 points above the CDS of Brazil and 143 points below the CDS of Turkey.
Additional Fitch Warning
Fitch Ratings said on Monday that South Africa could struggle to comply with a plan to control public spending by freezing public sector wages.
Finance Minister Tito Mboweni has outlined a plan to cut the government’s wage bill, which has risen 51% since 2008, as part of an effort to start reducing its debt trajectory after 2026.
Still, the government has not had a good track record of keeping a cap on public spending over the past decade, according to Jan Friederich, Fitch’s senior director of sovereign ratings.
South Africa faces the double challenge of slower growth and rising debt levels, Friederich said on Bloomberg TV. A plan to improve government finances through a public wage freeze could fail, he said.
“If you look back, the last decade, there have always been excesses in wage negotiations, even when the government’s offer was a little more generous than inflation,” Friederich said. Now, a wage freeze in an environment where there is still some inflation is quite a drastic measure. A lot of the savings depend on it and it’s very uncertain. “
Without state wage cuts, it leaves the government with very little room for maneuver, and the central bank is unlikely to cut interest rates further in the cycle.
The government’s debt projections for the next few years are also deteriorating, and if it chooses to increase spending to fuel growth, that could “exacerbate” the debt challenges, Friederich said.
“The government debt projections for the next few years are much higher than they were, say in the spring, and heavily dependent on next year’s salary negotiations,” he said.
Read: South Africa runs out of second chances
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