Rating Action: Moody's downgrades South Africa to Baa2; outlook changed to stable
Global Credit Research - 06 Nov 2014
New York, November 06, 2014 -- Moody's Investors Service has today downgraded the government of South Africa's debt rating to Baa2 from Baa1. The government's short-term debt rating is affirmed at a provisional Prime-2 ((P)P-2). The outlook on the rating was changed to stable from negative. Moody's also downgraded to Baa2 from Baa1 the rating assigned to the debt issued by ZAR Sovereign Capital Fund Propriety Limited.
The key drivers of the rating downgrade are the following:
1) Poor medium-term growth prospects due to structural weaknesses, including ongoing energy shortages as well as rising interest rates, further deterioration in the investor climate and a less supportive capital market environment for countries such as South Africa that are highly dependent on external capital.
2) The prospect of further rises in the government debt-to-GDP ratio implied by the low-growth environment, which even strict compliance with the government spending ceiling and somewhat smaller fiscal deficits are unlikely to arrest in the near term.
The assignment of a stable outlook reflects policymakers' commitment to reining in government debt growth over the medium term and the broad political support for a macroeconomic strategy, including the National Development Plan (NDP), tighter monetary policy and fiscal restraint, which should help stabilize the debt burden over the medium term.
In a related decision, South Africa's country ceilings for local currency debt and deposits remain at A1/P-1 and its country ceilings for foreign currency debt remain at A2/P-1. The long-term country ceiling for foreign-currency bank deposits was lowered to Baa2 from Baa1 while the short-term country ceiling for foreign currency bank deposits was unchanged at P-2.
RATINGS RATIONALE
- RATIONALE FOR THE DOWNGRADE TO Baa2
The first driver for the downgrade of South Africa's long-term debt rating to Baa2 is the weak outlook for real growth over the coming years, continuing the below-potential performance of 2012-14. Moody's has revised down its forecasts for real GDP growth to only 1.4% in 2014, followed by a 2.5% increase in 2015, and expects that the economy will not reach its long-run potential growth rate of roughly 3% until 2018 because of ongoing energy shortages and other structural constraints. These low projections are also subject to material downside risks from both domestic sources -- mainly new strike activity -- and external sources, particularly a slowdown in demand from China, South Africa's single largest export market, and weak growth in world trade generally. Even if such impediments are overcome, real growth is likely to come in below levels seen a few years ago, according to Moody's.
The country's structural weaknesses are meant to be addressed in the NDP, but will likely continue to hold back growth for a number of years. For example, while the development of South Africa's energy and transportation infrastructure is a key focus of the NDP, energy availability will remain challenging until at least mid-2017, when substantial new electricity generation capacity will come fully on stream. Since South Africa's exports are highly energy-intensive, shortfalls in electricity availability suggest that the current account deficit will remain at relatively wide levels of around 5.5% of GDP for several more years. Other essential elements of the NDP -- labor market reform and reforms to improve education standards aimed at raising the country's very low participation rate and normalizing industrial relations -- are important drivers of potential growth in the coming years, though as yet unproven.
South Africa's structural weaknesses are also a major factor behind the poor investment climate, which has been exacerbated by the extensive work days lost to strikes in recent years and heightened tensions over a multitude of socio-economic challenges still impacting the country 20 years after the democratic transition. Lagging investment has hindered efforts to raise growth to the 5%-6% level needed to reduce unemployment and raise real incomes as well as increasing the savings rate to levels needed to support higher levels of growth without exacerbating external imbalances. South Africa's weakened investment climate is particularly relevant in view of the less supportive capital market environment for South Africa and other countries that depend on capital inflows to finance large current account deficits.
Moody's says growth will also be vulnerable to the expected rise in policy rates as the Reserve Bank (SARB) gradually normalizes real rates into positive territory. Rates have been on hold in recent months as the pass-through from the depreciation of the rand since last May has been weaker than expected. When interest rates do rise, however, it will negatively affect lower-income households in particular, who are heavily indebted.
The second driver of the downgrade to Baa2 is the continued deterioration in the government's debt metrics that will likely occur in the next few years, even if, as Moody's expects, the government adheres to its announced expenditure ceilings. The debt burden has risen by about 20 percentage points to an estimated 48% of GDP this year, and debt affordability has diminished consistently since 2008/09. Although the government has stepped up its fiscal consolidation efforts to take account of lower growth in coming years, recurring fiscal deficits combined with weak growth will lead to a continued increase in its gross debt to nearly 50% of GDP by 2017/18, even according to official forecasts. Interest payments are the fastest-growing item in the budget, and Moody's projects that the interest-to-revenue ratio will continue to rise to 9% in 2015/16, from a low of 7.1% in 2008/09.
- RATIONALE FOR CHANGING THE RATING OUTLOOK TO STABLE
Moody's decision to change South Africa's rating outlook to stable from negative reflects policymakers' commitment to containing increases in government deficits and debt. According to Moody's, government efforts to restrict current spending -- including the wage bill -- to protect its infrastructure expansion efforts are an important part of its broader efforts to enhance longer-term growth prospects by eliminating infrastructure bottlenecks without significantly loosening fiscal policy.
The recent Medium Term Budget Policy Statement provided further assurance of continuity in macroeconomic policy and showed that the South African Treasury is no longer counting on a recovery of growth to bring down deficits in the future. Aside from cuts in the existing spending ceilings for 2015/16 and 2016/17, the statement outlines newly-lowered fiscal deficits that are limits that cannot be exceeded, which Moody's deems as important given downside risks to growth on both the domestic and external fronts.
Moreover, Moody's noted that South Africa's Baa2 investment grade rating reflects its position as the most developed country in Africa, offering by far the deepest capital market and one of the most sophisticated financial systems among emerging markets. The economy has a diversified productive base, with substantial value-added from domestic sources. The country's infrastructure is highly advanced compared with most other emerging markets and its institutions, most notably its judiciary, are stronger than many of its peers. Twenty years after the democratic transition, important achievements include the early establishment of macroeconomic policy credibility; an expansion of services, housing and utilities; and the emergence of a growing black middle class.
- WHAT COULD CHANGE THE RATING UP/DOWN
The successful implementation of planned structural reforms to enhance potential growth and reduce exposure to external shocks, combined with continued fiscal prudence, could exert upward pressure on the rating. Reforms resulting in higher domestic savings and investment rates and sustainable, stronger growth, alongside continued restraint in public debt accumulation and the ongoing implementation of the macro- and micro-level reforms embedded in the NDP, could also provide positive momentum to the rating.
South Africa's ratings could be downgraded if the official commitment to fiscal consolidation and debt stabilization falters, or if the investment climate deteriorates further, imperiling the availability of external financing for the current account deficit.
GDP per capita (PPP basis, US$): 12,507 (2013 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 1.9% (2013 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 5.3% (2013 Actual)
Gen. Gov. Financial Balance/GDP: -4% (2013 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -5.8% (2013 Actual) (also known as External Balance)
External debt/GDP: 38.9% (2013 Actual)
Level of economic development: Moderate level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 04 November 2014, a rating committee was called to discuss the rating of the South Africa, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks.
The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this rating action, if applicable.
Statement issued by Moody's, November 6 2014 (see full release here)
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