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SA’s long-term growth outlook remains weak post-election – Moody’s

South Africa’s debt metrics are likely to worsen in the short term.


NOMPU SIZIBA: After the market closed yesterday [Wednesday], Moody’s released their report on South Africa’s sovereign credit position, keeping the country’s credit rating at investment grade, but still one notch away from junk at Baa3. The report warns that South Africa’s debt metrics are likely to worsen in the short term, citing expected continued lacklustre economic growth and limited investment levels in the economy. However, the ratings agency says it does believe that the newly elected government will work in earnest to push through much-needed economic reforms to help turn the country’s economic fortunes around. But it doesn’t believe the results will be immediate.

My colleague, Ryk van Niekerk, caught up with Lucie Villa, the senior credit officer at Moody’s.

RYK VAN NIEKERK: Lucie, welcome to the show. The report is very comprehensive, unemotional and it clearly unpacks the challenges South Africa faces. The ones it seems you are the most worried about are rising government debt levels, especially at Eskom, and our poor economic growth performance of late – and the depressed forecasts.

Let’s start with state debt. You now include government guarantees to Eskom in your calculation, and you project that, if nothing changes dramatically, we may see total debt of over 70% to GDP by 2023. How significant is this risk to South Africa?

LUCIE VILLA: Thank you, sir. As you said, we identify that’s been the case for quite some time now. We specifically identified two main challenges in South Africa, a slow economic growth first, and then of course on the fiscal front some pressures coming both from spending and revenue. Of course, the two are linked because in the slow growth environment it’s also difficult to raise tax revenues. These are really the two main challenges that we have been identifying for quite some time in South Africa. And, as you pointed out, if we assume policy continuity – and when I say that I refer to 2018 in particular – then, based on commitments in the past of the government, the fiscal policy stance we had seen in 2018, and taking into account of course the difficulties at Eskom, then we would see that should see the debt to continually be trending up. 

It’s not a very steep increase. I must say it’s a kind of gradual, but steady increase. I think the main risk is probably twofold. One is that our rating analysis is a question of peers, and when we look at peers many of the Baa3-rated sovereigns we have are actually on a very deep front trajectory. Most of them are bringing their debt-to-GDP level lower. So that would be, you know, one of the reasons why such a trend will be negative from our perspective.

Here’s a factor that I think is important – that it also lowers the shock-absorption capacity of the government. So, when you have a relatively small debt, and a shock happens, then the fiscal authorities can step in, maybe provide a bit of stimulus to the economy. or take over the cost of strategic restructures, and yes, it will bring the debt-to-GDP level higher, but if this is from a relatively low base, then you have what we call shock-absorption capacity. The issue is that when you start reaching 70% of GDP you are losing that shock-absorption capacity.

Read more: SA’s debt surge must stop –  Moody’s 

RYK VAN NIEKERK: Moody’s has always been regarded, especially in relation to South Africa, as a very patient and lenient credit ratings agency. How do the South African metrics compare to other emerging markets? Put differently, how close are we actually to a downgrade?

LUCIE VILLA: It really will depend on what your outlook is in terms of the growth and the fiscals – I think that’s the reason why we explain that with the recent election now over, really all focus is on understanding what policies the new administration, the new government, when it forms, will bring forward. So that’s really when we know that we will better understand how far or how close South Africa is to either a downgrade or actually an upgrade. We have a stable outlook at the Baa3.

But if you look at peers, we focus on emerging market peers, in particular, I think that really what is striking is the slow growth, and we are going back to the challenges that are very well known in South Africa, and if you look at the peers we mention in our report you can see that South Africa is probably one of the slowest economies we have.

The trend also is interesting, because the growth is low but it’s even slowing, going to an even lower level, which also is something which I think is important to bear in mind. And also I think we try to explain better what can explain that trend. So we went into productivity growth comparison and so on and so forth.

On the fiscal side, as I was alluding to it at the beginning, the main difference for us is not so much the level of that today, because when you look at debt-to-GDP, whether you include the guarantees of Eskom, whether you look at the broader state-owned enterprise sector, and you make a comparison, today the South African government is fairly well in line with that of the developing rated peers. I think the main difference is on the trajectory, and no policy change, we think that debt would rise to 70% of GDP; that would then differentiate South Africa from Baa3 would bring South Africa closer to another peer discussion or report, which is more rated at Ba1.

So I guess this gives you an idea of if there is no effective response on the part of the authorities where we would go and where we would be now more in line with the Ba1 rating.

Then, looking at the strengths, I think it’s very important to remind ourselves that the strength has a chance in South Africa, and maybe it’s the reason why they are less widely discussed. But it’s not business they haven’t change much that they are not there, and that we don’t take them into account. So I think it’s again good to keep in mind what these trends are, and it’s a diversified economy. To be perfectly honest compared with peers, that’s something that we are finding … emerging markets that we looked at.

What I think is different, and maybe makes South Africa more unique compared to emerging market peers, is more related to the government access to a quite deep domestic capital market, which again, if you compare it with peers, this is where South Africa really stands out, and by a very large extent, I would say. So that’s really we are seeing South Africa actually faring much better.

RYK VAN NIEKERK: The South Africa government is very aware of the consequences of a downgrade, and there is a lot of effort to engage with rating agencies such as Moody’s to try and mitigate such a step. What do you think of the leadership in South Africa currently in charge of the economy, and what have your interactions been with, say, the minister of finance, Tito Mboweni, and President Cyril Ramaphosa?

LUCIE VILLA: What I can say as the rating agency is that we have a participative rating of South Africa, which means that we have access and we have engagement on the part of the authorities, and that provides a basis that leads us to get to the ratings. In terms of more detailed information of our relationship, that is not something that I would expand on. Most of it is usually more in the confidential domain.

RYK VAN NIEKERK: That was Lucie Villa, the vice-president of Moody’s and one of the authors of the Moody’s update on South Africa.

NOMPU SIZIBA: Well, to get her slant on Moody’s approach on the country’s sovereign credit rating, I’m joined on the line by Lullu Krugel, the chief economist at PwC Africa. Thanks very much for joining us, Lullu. You heard parts of that interview. Do you get Moody’s rationale?

LULLU KRUGEL: Nompu, completely. I think that what Moody’s raised are definitely issues that we have been aware of for quite some time, and that they have raised and the other rating agencies have raised for the past couple of years, and which we know that they have been watching. I suppose, in short, there are two things for me that stood out from the conversation that Ryk had with Lucie as well as from the report itself, and that is our relative strengths to either developing market peers have versus the areas where we may not be doing that great. If one thinks, for example, she focused quite a bit on government debt, and of course that expectation of an extreme 70% of GDP. It’s a little bit higher than government’s own estimates in the new budget speech.

But if you compare that, for example, with our position in 2007 – and I think that’s an important distinction that she made – right before the financial crisis, we were around 27, 28, 29% debt-to-GDP. So that’s the important cushion that she talks about that we don’t have now. And if you look at what’s happening in the global economy, on the trade wars, the slowing growth from China and other parts of the world, I think that is a little bit of a concern, if there is an external shock coming from the south-east economy.

NOMPU SIZIBA: Obviously she touched on the fact that it doesn’t look as though we are going to get much traction with economic growth in the short term, and there is a concern about what the taxman will be able to collect from the economy because it’s still moving at a slow pace. And then obviously there are still the economic imperatives that need to be dealt with – the social aspect, education, and so forth. So then, with your great brain, how do we fix it, how do we go about getting to a point where we peak at 70%, if need be, and come back down while still trying to get growth going?

LULLU KRUGEL: There are a couple of difficult decisions that should be made, and I think some of them are already in place. We’ve seen certain fiscal measures being implemented earlier this year in the budget speech. But I think everybody really is looking at what President Ramaphosa is going to do with the size of the cabinet, and the size of government, and so forth. There will have to be a very firm hand on government expenditure that does not generate economic growth. So, everything that might not be conducive to economic growth. That being said, as you say, we’re sitting with poverty, inequality, some deep social issues. So in terms of social spend, it’s going to be very difficult to bring that back in.

On the positive side, I think we understand that one of the best things we can do at this point in time for the economy is foreign direct investment and foreign … businesses in South Africa … and President Ramaphosa has worked hard over the last year to actually drive that forward and … will change the direction, so I think now after the election when there is more certainty, that momentum will pick up speed because from government’s side there simply isn’t room, so we need that private-sector investment to get jobs going. And if you look back to 2006/7 we had unemployment of under 20%, and that was coupled with economic growth of around 5%.

NOMPU SIZIBA: Well, Lullu, we are going to leave it there. More to talk about, but not enough time. Thank you so much.

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