The historically large contraction in South Africa’s gross domestic product (GDP) figures for the first quarter of 2019 signals bad news not only for the government’s attempts at fiscal consolidation but will also weigh negatively on bank’s credit quality.
Statistics South Africa recently announced that the country’s economy shrank by 3.2%, the largest contraction since the global financial crisis 10 years ago. The news, coupled with the ruling party’s mixed messaging about the mandate of the South African Reserve Bank, sent shock waves across the rand, which peaked at R15.17 to the dollar on Friday from R14.47 on Monday, June 3.
This also led to Moody’s, the last major sovereign rating agency to hold South Africa’s debt at investment grade, lowering the country’s growth projections for 2019 to 1% from 1.3%.
“The quarterly decline, the largest in 10 years, is credit negative for the government of South Africa’s revenue and policy options and South African banks’ asset quality and profitability,” said Moody’s in a research report on Monday.
“We assume economic activity recovers over the rest of the year as policy uncertainty dissipates following May’s general elections. The government’s policy objective to boost economic activity while consolidating its fiscal position will prove even more difficult in this environment,” Moody’s added.
The rating agency said profitability on loans will face additional negative pressure in the low growth environment that will “suppress business opportunities and loan demand”.
“Banks are already competing for better quality borrowers, and revenue is under pressure amid competition from new entrants and widespread migration to mobile and digital platforms by established players,” Moody’s said.
Increase in non-performing loans
There has been a gradual increase in non-performing loans over the past few months that were sitting at 3.8% in April 2019 from 3.7% in December 2018. At the start of 2018, the rate of problem loans was 3.3%.
Moody’s said these numbers are, in part, a reflection of the deterioration of credit extended to corporates in the construction, mining and retail segments which have come under severe pressure. “We expect that the performance of bank loans will remain hampered by South Africa’s weak economy, which will strain borrower cash flows and make it more difficult for them to manage loan,” said the rating agency.
However, Moody’s said that the big five banks, which make up 90% of the banking system’s assets, would be able to manage the pressure on profitability and deteriorating asset quality. This is Standard Bank, Nedbank, Absa, FirstRand and Investec.
In addition, the fact that South African corporates’ debt to GDP ratio is lower than their counterparts in other emerging markets and the decline in household debt will serve as mitigating factors to the current challenges.
Moody’s postponed the issuance of a new rating assessment of South Africa in March kicking the ball down to November. Should it junk the country’s debt, South Africa will be ejected from the major Citi World Government Bond Index triggering capital outflows of hundreds of billions of rands.