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Recent credit rating downgrades by Moody’s Investor Services and Fitch Ratings, which give South Africa its lowest credit rating since 1994, indicate that rating agencies are not convinced that the government’s proposed economic recovery plans have much substance, says Paul Marais, managing director of NFB Asset Management.
Rating agencies say the government’s proposed fiscal consolidation plan is unconvincing and the plan to freeze public sector wages is unlikely to come through. This last proposal is already being challenged through the judicial system.
The bottom line is that none of the rating agencies has much hope for a short-term economic recovery, although their expectations of the magnitude of the GDP contraction for 2020 have moderated to approach -8% from -10% expected.
Despite the official view that the president’s annual investment conference last week was a resounding success, the reality is that investors are not lining up to invest in new mega-projects. In fact, a number of projects that were included as part of the numbers at last year’s conference have subsequently been frozen.
Investment spending has slowed significantly in recent years to the extent that spending in 2019 was at its lowest levels since 2012.
To attract investment, South Africa urgently needs to implement economic reforms, including implementing business-friendly legislation in a faster place. This should include political and legal certainty around issues such as expropriation without compensation.
What is becoming increasingly clear is that the government’s spending priorities are questionable at best. This is compounded by the failure of nearly all state-owned companies, resulting in the need for ongoing bailouts.
While the government has no choice but to rescue strategically important entities like Eskom, its determination to rescue a less strategically important organization like South African Airways is not so easy to understand. At the same time, it raises the question of the extent of other unnecessary expenses in government departments.
South Africa’s record on implementation is poor. Fitch has said that even if the president’s Economic Recovery and Reconstruction plan is implemented, “the effect on reforms would be limited and would take time to accumulate.” In a similar vein, Moody’s maintains that changes are unlikely due to economic and social constraints.
The absence of major new greenfield investment projects should act as a warning system. Until the government starts tackling crippling public debt, solves the risk of loss of charge and tackles Eskom’s growing debt problem, relaxes the empowerment rules and creates a more favorable environment for investors and businesses, there are few incentives for foreign investors to consider SA.
The fact that both Moody’s and Fitch have pushed South Africa’s credit rating further into the trash with a negative outlook points to a very real threat of further downgrades. Expect more announcements on this topic in February next year around the time of the Finance Minister’s budget speech.
Fortunately for South Africa, the market reaction to the current set of markdowns has been quiet. Optimistic sentiment from emerging markets and a smoother US presidential transition appears to be a more significant set of forces than any specific malaise from South Africa.
The reductions, however, have an implication for the country, resulting in a higher cost of borrowing for the state. At this stage, South Africa cannot afford a higher cost of borrowing, particularly given rising levels of debt relative to GDP and lower tax revenue collection as a result of the blockade.
The problem with borrowing to pay debt service is that no injection is being made into the generators of economic growth. At the current rate of decline, South Africa will soon be unable to borrow sufficient amounts to pay its debt service. We are rapidly entering a vicious cycle in which more and more government revenues will be spent on debt service, at the expense of maintaining social spending.
The current situation cannot be attributed solely to Covid given that South Africa’s structural problems existed long before the pandemic. What 2020 has done, however, is accelerate the country’s seemingly inevitable race to the fiscal cliff.
The February budget announcement will be significant. Expect higher taxes since cutting social subsidies would give the government a very poor outlook in the current environment.
While tough choices and tough choices are necessary if South Africa is to achieve a significant degree of economic recovery, recent history indicates that the ruling party has little appetite for them.
- By Paul Marais, Managing Director, NFB Asset Management
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