According to Old Mutual Investment Group Chief Economist, Rian le Roux, now there is a better chance that S&P will leave the rating unchanged this week, following the positive outcome from Moody’s last week. Fitch’s decision to keep SA’s sovereign rating unchanged at one level above non-investment grade, but changing the outlook from stable to negative, is an indication that a downgrade to non-investment grade is possible unless prospects for the economy improve materially, and underpins government’s intended longer term fiscal consolidation.
Le Roux believes that while SA’s ratings from Moody’s and Fitch remains in investment grade for now, the longer term risk is still that, failing a material improvement in SA’s economic growth prospects through growth-enhancing structural reforms, SA could be subjected to multiple downgrades. Such an outcome could cause capital flight, a slump of the Rand, an inflation surge and will leave the Reserve Bank with no choice but to raise interest rates further.
“As agencies typically first change the outlook, before actually changing the rating, the negative ratings from all three agencies imply that the urgency has increased for SA to get its’ economic and fiscal house in order,” he explains. “The implication is that SA will need to work harder to implement structural reforms to restore confidence and encourage investment.”
In its review, Moody’s noted the strength of South African institutions that support the investment grade rating, citing the public prosecutor dropping charges against Pravin Gordhan and the public protectors State of Capture report as positive developments. But, it also lists a number of concerns including political infighting, low growth and unemployment, which it believes pose the greatest risks to the South African economy.
Le Roux says that the most significant risk in the short term remains whether or not S&P, which currently has South Africa at one level above junk status, will downgrade its sovereign rating to sub-investment grade. “S&P might give SA another reprieve, as there have been a number of positive developments over the past few months, over and above the ones mentioned by Moody’s.
These include strong and growing societal opposition to corruption and mismanagement in the public sector, a solid commitment to fiscal consolidation in the Medium-term Budget, a welcome lack of disruptive strike action, a much improved rainfall season, growing confidence that the economy is past the cyclical low, reduced upward pressure on local interest rates and a strong indication from government that corrective action at a number of state-owned enterprises has moved up the policy priority agenda,” he says.
However, Le Roux believes that S&P could downgrade SA’s local credit rating – currently three levels above non-investment grade – next week, on account of the rising interest burden of government debt and the fact that fiscal flexibility is still constrained.
He adds that the past six months have seen little in terms of policy reforms and this keeps the risk of an actual downgrade by S&P alive. “The recent announcement on the suggested minimum wage does create a bit more certainty about the issue, despite strong opposing views and further negotiations still to be conducted,” he explains. “There have been indications that announcements could soon be made on the mining charter and labour reforms, creating some more policy certainty, but the timing is uncertain and it is obviously still uncertain as to whether the nature of these reforms will satisfy the agency.”
Another concern is the uncertainty around how S&P views SA’s institutional strength – currently sitting at a neutral rating. “If they change this to negative on account of the political tensions concerning the Finance Minister and concerns over the broad direction of economic policy, then they could downgrade us. However, we don’t believe at this stage that they will.”