SA’s growth has been too slow for too long, confining the country to a middle-income trap, worsening its debt position and causing real GDP per capita to drop significantly over the past four years.
Unless SA is able to reignite growth, its economic problems will continue to worsen and rating downgrades will follow.
This is the message from Moody’s and Fitch rating agencies. Late last week, Fitch affirmed SA’s BBB- foreign rating on the bottom rung of the investment grade ladder but cut the outlook from "stable" to "negative".
Moody’s avoided issuing a rating action, providing a detailed credit opinion instead in which it justified maintaining the negative outlook on SA’s Baa2 ratings based on the risk that the country could fail to achieve the gradual growth recovery and debt stabilisation on which its ratings rely.
Baa2 is two notches above noninvestment grade. This means Moody’s keeps SA’s rating one notch higher than those from Fitch and S&P Global Ratings. Like Fitch, S&P has SA’s foreign rating pegged on BBB- with a negative outlook.
However, all eyes are now on S&P, which is due to make its ratings announcement on Friday, December 2.
The market expectations of S&P downgrading SA to junk have fallen to about 50% in recent weeks, from as high as 70% earlier this year. The catalyst for this positive sentiment, it seems, is lower political risk following the withdrawal of fraud charges against finance minister Pravin Gordhan.
Another plus has been the improvement in SA’s growth outlook, shrinking current account deficit, ongoing fiscal discipline, and nascent reform momentum in the labour and energy markets.
But S&P is not politically naive. It understands that ultimately growth is hostage to SA’s fraught politics. If it downgrades SA to junk, politics will be the main reason.
"The negative ratings from all three agencies imply that the urgency has increased for SA to get its economic and fiscal house in order," says Old Mutual Investments chief economist Rian le Roux. "The implication is that SA will need to work harder to implement structural reforms to restore confidence and encourage investment."
Confidence in SA’s ability to get to grips with its economic challenges has taken a hammering, given the political campaign to oust Gordhan and the extent of state capture that has emerged over the past year.
Both Fitch and Moody’s highlight the negative impact of politics on economic development in their assessments, prompting DA shadow finance minister David Maynier to say: "Politics is killing the economics in SA."
Fitch says political risks to standards of governance and policy making have increased and remain high. This is a key driver of its decision to change SA’s ratings outlook to "negative".
"The infighting within the ANC and government is likely to continue over the next year," it says. "In Fitch’s view, this will distract policymakers and lead to mixed messages that will continue to undermine the investment climate, thereby constraining GDP growth."
It notes that "ANC factional battles may undermine government efforts to improve the governance of state-owned enterprises (SOEs), which could affect the plan to streamline the SOE portfolio".
At the same time, business confidence remains depressed and investment has continued to contract, Fitch warns.
Similarly, Moody’s negative outlook recognises the risks associated with political uncertainty and low business confidence as well as a challenging environment characterised by low growth.
Since 2014, SA has experienced one of the slowest rates of growth among emerging markets, contributing to the country remaining stuck in a middle-income trap, Moody’s notes. SA’s real GDP per capita is estimated at US$5,140 in 2016, significantly lower than the peer group average of $9,188.
By S&P’s reckoning, SA is already junk-rated in terms of its GDP growth performance and GDP per capita income, which has dropped since 2012 and is lower than in many peer countries (see graph).
Fitch notes that even if SA’s real GDP growth rate recovers in line with its own and national treasury’s estimates from about 0.5% this year to about 2% in 2018, per capita growth will only just inch into positive territory by 2018.
Moody’s expects SA’s real GDP per capita to fall in absolute terms this year, in line with its real GDP growth forecast of 0.2% for this year. After that, it projects that SA’s "very fragile" growth will recover slowly, rising to 1.1% in 2017 and 2% in 2018 as some of the bottlenecks — such as the drought, electricity gap, and high frequency of strikes — ease up.
"However, potential growth will be constrained by both the lack of decisive momentum in structural reforms and unfavourable global conditions characterised by lower-for-longer projections for global growth, investment and trade," it warns.
Given the domestic and external challenges to SA staging a meaningful recovery, the risks to the credit rating remain to the downside, even if S&P does not cut SA’s foreign ratings to junk this week.
"Potential growth remains muted and real GDP per capita growth will likely struggle to outpace population growth in SA over the next three years," conclude Momentum Investments analysts Herman van Papendorp and Sanisha Packirisamy in a research note.
"Low economic growth continues to constrain SA’s economic assessment and rising political tensions are accentuating vulnerabilities. Consequently we are, in our view, not yet out of the woods regarding the foreign rating ..."
But why, given SA’s muted anticipated growth recovery and the risk that it will not achieve even this limited revival, has SA not been firmly downgraded already?
It is mostly thanks to national treasury, with Fitch and Moody’s both noting SA’s record of sound fiscal management.
Treasury has stuck to its self-imposed expenditure ceiling since 2013 and, though there has been some fiscal slippage due to disappointing growth, the target of achieving a primary surplus remains in sight.
Fitch says that as a result of the more aggressive fiscal consolidation measures outlined by Gordhan, SA’s fiscal targets "now look only mildly optimistic" and it expects these to be roughly adhered to.
When it comes to SA’s debt profile, the country’s standing has slipped compared with its peer countries as it has accumulated debt faster, but SA’s position still remains broadly comparable.
Crucially, the currency composition and term structure of SA’s debt remains highly favourable while the country’s well-developed domestic financial markets reduce SA’s financing risk.
Also counting in SA’s favour, according to national treasury, is cabinet’s recent approval of a revised Integrated Energy Plan (which pushes out the start-date for the intended nuclear build considerably) as well as a proposal that SA institute a minimum wage of R3,500/month.
The latter is part of a wider deal which is expected to include the introduction of secret strike balloting and advisory arbitration to help curb indefinite strikes. Moody’s is hopeful these reforms will raise the country’s labour utilisation rate and productive capacity.
The CEO Initiative, Business Leadership SA and Business Unity SA see the ratings updates as a "vindication" of the efforts by government, labour and business to drive structural reforms to raise the growth rate.
Recognising that a lot of work remains, they have pledged to keep the structural reform programme going, while guarding the independence and capacity of SA’s institutions.
Yet, despite all these efforts, the fact is that SA remains perilously close to a junk rating.
Without a change in the political climate, further downgrades remain just a matter of time.