What it means: Brace for further charges against Gordhan; likely downgrade to junk.
There is a narrative gaining currency in SA, but particularly among foreign investors, that the fraud charges against finance minister Pravin Gordhan will not hold up in court, that President Jacob Zuma has overreached himself and that this will spell his end, leading SA to a positive economic turnaround.
However, several political and economic analysts have warned that this view underestimates Zuma’s staying power, suggesting that financial markets are underpricing SA’s political risk. This means the rand could fall a lot further if Gordhan is axed and SA loses its investment-grade credit rating.
The view that Gordhan will prevail has been bolstered in the past week by two developments. First was the mass outpouring of public support for Gordhan following the National Prosecuting Authority’s (NPA’s) decision to charge him with fraud. This was accompanied by statements of solidarity from within the ANC, including from several cabinet ministers and deputy president Cyril Ramaphosa. Second was Gordhan taking the fight against his accusers into open court.
In an explosive court application last Friday, Gordhan revealed a list of 72 suspicious transactions totalling R6.84bn by the Gupta family and its companies, as reported by SA banks to the Financial Intelligence Centre.
These transactions are the real reason why the big four banks closed the Guptas’ Oakbay Investments’ accounts earlier this year, submits Gordhan, who wants the court to order that no minister of finance is legally empowered to intervene in the relationship between the banks and the Guptas.
Gordhan’s case dispels the myth that the Guptas are victims of a conspiracy perpetuated by the big banks and aided by national treasury. It leaves them, and mineral resources minister Mosebenzi Zwane, with a serious case to answer.
It was Zwane’s committee that probed the reasons for the banks’ closure of the accounts and concluded that "all of the actions taken by the banks and financial institutions were as a result of innuendo and potentially reckless media statements". Treasury, he found, was complicit in having failed to protect Oakbay.
Whether or not Gordhan is removed as finance minister, the view gaining ground is that his court application will expose enough dirty linen to swamp the Gupta family and the president. If not, the public protector’s report into state capture — expected to implicate Zuma and the Guptas in wrongdoing — should do it. Thuli Madonsela’s report remains under wraps, pending interdicts by Zuma and co-operative governance minister David Des van Rooyen.
"The conflict between national treasury and the presidency has spilled into the streets, courts, the political parties and public opinion," says BNP Paribas Securities political analyst Nic Borain. "Zuma is wrong-footed, injured and his allies are in serious trouble — but he is not even down, let alone out. Zuma remains the most dangerous player on the field and, despite the negative news surrounding him, it’s way too early for dancing in the streets."
Nomura economist Peter Attard Montalto agrees: "We should not underestimate the fact [that Zuma] appeals to a particular internal constituency that the market struggles to understand. Nor should we underestimate his ability to undertake what the market might deem an irrational course of action, like a scorched-earth strategy. This is now what we most fear as it seems simple routes out ... are increasingly unavailable."
Attard Montalto predicts a counter attack by Zuma’s faction, possibly involving the NPA charging Gordhan over the establishment and conduct of the Sars "rogue unit". More revelations from Gordhan’s camp are also possible, given the structure of his court motion.
If Borain and Attard Montalto are correct, political risk in SA is significantly underrated. Consider the rand’s relatively muted reaction to the past week’s events. It weakened by 44c or 3% to close at R14.36/$ last Tuesday on the NPA’s announcement that Gordhan was to be charged with fraud. But then it traded sideways with low volatility to start this week at much the same level (R14.32/$).
SA’s five-year, dollar-based CDS spreads (which provide a measure of credit risk) have also held up remarkably well. At 262bp, they are only 13bp higher than before the NPA’s move. This is nearly 130bp narrower than the level reached in February after Nenegate and the start of concern at the Hawks’ harassment of Gordhan over the "rogue unit".
According to BNP Paribas Securities, though market pricing shows that SA is considered the country most likely to experience a sovereign rating downgrade (see graph), the odds of this happening by the end of the year are just above 60%. In May the odds were about 70%.
BNP’s Jeffrey Schultz says the markets haven’t reacted more adversely to SA’s "Game of Thrones" because conditions in other high-yielding emerging markets like Brazil, Russia and Turkey are less palatable.
"If you are a fund manager ... and you see an economy like SA that has a 10-year bond yield of 9%, inflation which looks to have peaked, and believe the political environment is on the verge of self-correcting, the real yield picture here over the next 12 months looks incredibly appetising."
This view is at odds with the real possibility that Gordhan will be fired in the next few weeks and that SA will be downgraded to junk on December 2 at S&P’s next review. S&P has SA’s foreign currency rating pegged at "BBB-", on the last rung of the investment grade ladder with a negative outlook.
By S&P’s reckoning, SA is already junk rated in terms of its GDP growth performance and GDP per capita income.
The only thing keeping SA from being thrown to the wolves has been treasury’s adherence to the expenditure ceiling and its drive, with business, to expedite structural reforms. Treasury’s steadfast goal has been to restore confidence and put the country on a faster, more sustainable growth path.
Usually the removal of an individual or team would not move the dial on a country’s credit rating. But Gordhan’s dismissal now would qualify as an "extraordinary event", says S&P’s sub-Saharan MD, Konrad Reuss.
"In June, we took a lot of comfort from treasury’s policies and attempts to pursue accelerated fiscal consolidation — that’s Gordhan’s handwriting there, and that’s why he and his team are so important to us," Reuss adds. "We also took some comfort from the impetus in structural reform and that it would pick up some momentum. These results are probably mixed, which is why fiscal consolidation is so important."
Earlier this year, government gave ratings agencies the impression that these reforms, in particular to state-owned enterprises (SOEs) and the labour market, would be swift and smooth.
While the SOE environment has lurched from one scandal to another, the labour stability agreements reached by the technical task team in Nedlac are significant and could well improve conduct during strikes.
Though the agreements still require political endorsement, Business Unity SA CEO Khanyisile Kweyama feels that, if adopted, "they will mark a decisive shift towards achieving labour relations stability" in SA.
"These quick wins are so important given the heated political debate," says Reuss. "SA has a resilient economy. The irony is that with the right leadership, setting the right framework, SA would be in a different place."
Old Mutual’s Ralph Mupita says the CEO Initiative is engaging government at the highest level over last week’s developments. "We have a very small window to avoid a downgrade and should use it," he warns.
"SA has a history of pushing itself to the brink but we don’t want to be going to the brink here. If we lose our investment-grade rating it can take a very long time to get it back again, and if S&P moves, other ratings agencies may follow."