Late on Friday evening Moody’s became the last of the rating companies to cut South Africa’s sovereign credit rating to junk with a negative outlook citing continued deterioration in government’s fiscal strength and weak economic growth.
“Moody’s does not expect current policy settings to address effectively. Both outcomes speak to weaker economic and fiscal policy effectiveness than Moody’s previously assumed,” it said in a statement released on Friday evening.
“The negative outlook reflects the risk that economic growth will prove even weaker and the debt burden will rise even faster and further than currently expected, weakening debt affordability and potentially, access to funding,” it said.
The announcement comes as SA concludes its first day of a nationwide lockdown which has seen almost all economic and productive activity, except for the functioning of essential services, slow or completely shut down as citizens remain at home to stop the spread of the novel coronavirus known as Covid-19.
When it rains it pours
In a statement, the National Treasury said that Moody’s decision “could not have come at a “worse time” as the country continues its battle with the Covid-19 virus which has infected 1170 people and killed one person since the first case was announced three weeks ago.
Treasury said that the impact of the virus has crossed over to multiple sectors in the economy including the financial markets which have experienced great volatility and a high sell-offs in equities as investors move their money to safe-haven securities.
“The sovereign downgrade will only add to the prevailing financial market stress,” said Treasury”. “These two events will truly test South African financial markets”.
The announcement is significant because it signals SA’s exit from the FTSE World Government Bond Index (WGBI) which requires a sovereign to have at least one investment-grade rating by one of the credit rating agencies. S&P and Fitch had already junked SA’s long-term and local currency debt ratings in 2017.
Global fund managers who have investment-grade mandates will be forced to sell-off their South African bonds by the end of April, the new date in which the WGBI will rebalance its indices due to prevailing global market conditions marked by unusual illiquidity and volatility.
Foreigners hold 37% or R800 billion in the countries total domestic government bonds which are expected to “substantially decline with the impact of Covid-19 and the downgrade”,
“Therefore to say we are not concerned and trembling in our boots about what might be in the coming weeks and months is an understatement,” said Finance Minister Tito Mboweni
Reforms are not promised
In its reasoning, Moody’s said South Africa was “entering a period of much lower global growth in an economically vulnerable position” due to electricity supply constraints, persistently low business confidence and investment and labour market “rigidities” which have suppressed the country’s economic growth.
“Fiscal space is very limited and looser monetary policy will not address underlying structural problems,” said Moody’s.
“The unprecedented deterioration in the global economic outlook caused by the rapid spread of the coronavirus outbreak will exacerbate South Africa’s economic and fiscal challenges and will complicate the emergence of effective policy responses”.
While there has been a progression in initiatives meant to encourage the creation of jobs and improve competition “progress on structural economic reforms has been very limited,” it said adding that it expected growth to remain depressed in the coming years.
“Structural issues such as labour market rigidities and uncertainty over property rights generated by the planned land reform remain unaddressed. Moreover, a strategy to stabilise electricity production has been slow to emerge and has yet to prove its effectiveness”.
Debt to soar
Government debt is expected to rise over the coming years irrespective of the scenario.
“Debt-to-GDP increased by 10 percentage points (ppts) over 2014-18 and will rise by a further 22 ppts over 2019-23 under Moody’s baseline projections,” said Moody’s.
It noted that any fiscal consolidation would come from arresting the growth on the public sector wage bill which could prove difficult as the government looks to save R160 billion in the next three years by keeping growth below inflation. This goal entails reviewing the final year of the 2018 wage agreement which comes into effect on 1 April, a proposal which has been rejected by organised labour.
“The negative outlook reflects downside risks around economic growth and fiscal metrics, that could lead to an even more rapid and sizeable increase in the debt burden, further lowering debt affordability and potentially weakening South Africa’s access to funding,” it said.
Moody’s said the possibility of South Africa climbing out of junk territory was “unlikely in the near future” given the negative outlook.
“Moody’s would likely change the rating outlook to stable if the government’s medium-term fiscal consolidation were to proceed broadly in line with the rating agency’s central expectations, with prospects of a slow but durable pick-up in growth and financing risks remaining low”.
“In this scenario, Moody’s would likely see a gradual reduction in South Africa’s primary deficit in the next few years, with increasing assurance that government debt will stabilise comfortably below 90% of GDP,” it stated.