In March, South Africa got some much-needed relief from Moody’s Investor Service as the rating agency confirmed the economy’s foreign-currency sovereign credit rating at Baa3 and upgraded the credit outlook from ‘negative’ to ‘stable’. Under the stewardship of President Cyril Ramaphosa, the Moody’s assessment was that the erosion of SA’s institutions would gradually reverse.
But six months later, with a new finance minister and a technical recession, what metrics should we watch to predict the rating agency’s latest actions?
Second quarter 2018 data reveals that the economy had experienced a technical recession, with a decline of 0.7% on a quarter-on-quarter seasonally-adjusted annualised (qqsaa) basis. Global headwinds only exacerbated the situation, as the markets remained jittery over the threat of a global trade war, which put even more pressure on an already weak rand in addition to rising oil prices.
In the rating space, however, economic strength denotes a country’s intrinsic ability to honour its debt obligations and deal with various exogenous shocks. Interestingly, some vital drivers of the economic assessment are the expected economic growth trajectory, potential economic growth and the diversification of the economy.
Now, the expected economic growth trajectory remains a tough metric as both the World Bank and the International Monetary Fund (IMF) revised their projections for SA downward to 1% and 0.8% respectively. Annabel Bishop, group economist at Investec, says: “It will dampen Moody’s sentiment but Moody’s is likely to continue with its wait-and-see attitude. Moody’s has already put out a brief reaction to SA’s recession.”
Peter Attard Montalto, head of capital markets research at Intellidex, concurs, saying: “The shifts in forecast will make Moody’s very negative and keep the risk of an outlook downgrade alive but in reality it is probably going to want to wait until after the budget at least.”
On the contrary, Ettienne le Roux, chief economist at Rand Merchant Bank, says this is not a given. “As it stands, Moody’s already expects GDP growth to slow to 0.7% – 1% in 2018. In other words, these IMF and World Bank forecasts are already ballpark what Moody’s has incorporated into SA’s credit assessment.”
Last month, Moody’s lead analyst Lucie Villa said: “We think things look fairly stable and the worst is probably behind us.”
‘Probably’ being the action word in this sentence as the Zondo Commission of Inquiry into State Capture continues with its attempt to leave no stone unturned.
Institutional strength is a key metric for foreign investors who are considering entry into any country and often trickles into local investor confidence, and a transparent, credible and consistent policy framework will be considered on the institutional strength metric.
South Africa continues to see weak fundamentals, particularly weakened institutions and competitiveness coupled with rising government debt ratios and, as a result, both business and consumer confidence are subdued.
Meanwhile, the appointment of Tito Mboweni as the new minister of finance earlier this week might be considered a positive by credit ratings agencies. “Ratings agencies are unlikely to be overly concerned by this rotation, and will rather focus on the credit dynamics that will be published in the Medium-Term Budget Policy Statement,” says Citadel director and chief investment officer George Herman.
He also notes that Mboweni’s experience and confidence should stave off any risk of a credit rating downgrade despite a challenging fiscal environment – and, as a well-known and respected government official, his appointment is in fact likely to yield numerous positive spin-offs in the short term.
Nevertheless, is it too early to cash in on the ‘Tito premium?’ Says Montalto: “They will welcome Tito but also be cautious in not being able to change the outlook in any way yet – on growth, reforms, fiscal policy – just because he is there. As such, I see his arrival as pretty ratings neutral.”
Despite seeing a premium on the monetary policy front, South Africa lags on the fiscal institutions with Sars and Treasury marred in scandals over the last three years.
Constraints to growth in South Africa
“From a credit rating perspective, what matters are the policies the new finance minister will pursue and there is no reason at this stage to believe he will deviate from the Treasury’s existing plan,” says Le Roux. “Moody’s will probably wait for the MTBPS on October 24 before making any concrete changes to SA’s sovereign rating.”
Fiscal strength measures the health of a government’s finances with an examination of the debt structure and debt portfolio in line with risk.
Despite South Africa’s fiscal deficit as a percentage of GDP registering at -4.3%, the IMF says: “Fast growing debt has constrained policy space. As a result, per-capita growth has turned negative; the poverty rate stands at 40%.”
Consequently, unemployment has crept up to 27% – and almost twice that level for the youth – and income inequality is one of the highest globally.
In August, Moody’s highlighted two specific risks to its budget deficit forecast: rising interest costs and further potential support for SOEs, which could only add pressure on the already existing fiscal stress.
“Moody’s already expects a budget deficit bigger than the 3.6% National Treasury projected in the February Budget. The number thus needs to notably overshoot Moody’s existing expectation to raise renewed concerns about fiscal slippage,” says Le Roux.