The country can collectively breathe a little easier this morning as the Moody’s verdict is in. Our credit rating outlook is revised from stable to negative, but not downgraded to sub-investment grade (junk) at this stage.
Moody’s says its decision to change the outlook to negative from stable “reflects the material risk that the government will not succeed in arresting the deterioration of its finances through a revival in economic growth and fiscal consolidation measures.
The challenges the government faces are evident in the continued deterioration in South Africa’s trend in growth and public debt burden, despite ongoing policy responses.”
The report was issued at close to midnight on November 1.
Written by Lucie Villa, senior credit officer in Moody’s sovereign risk group, it says “while high unemployment, income inequality and the social and political challenges they imply for policymakers are long-standing features in South Africa, the obstacles that they pose to the government’s plans to raise potential growth and contain fiscal deficits are proving more severe than expected a year ago.
“Acute financial stress for state-owned enterprises (SOEs), in particular Eskom Holdings, continues to require sizeable ongoing support from the government. The development of a credible fiscal strategy to contain the rise in debt, including in the 2020 budget process and statement, will be crucial to sustain the rating at its current level.”
The negative outlook signals in part Moody’s rising concern that the government will not find the political capital to implement the range of measures it intends, and that its plans will be largely ineffective in lifting growth, Moody’s said.
Finance Minister Tito Mboweni, who earlier in the week described by credit rating agencies as friends and tormentors, said he had hoped for a different outcome, but acknowledged the rating action by Moody’s with a heavy heart.
“Fellow South Africans, now is the time to roll up our sleeves and do what we have to do. It is now or never. We need all hands on deck. Government, labour, business and civil society, we need each other more than ever before. This country is ours and it is only us who can turn it around.”
Moody’s said its rating rests on the government’s ability to quickly develop a credible strategy to halt and ultimately reverse the rise in debt.
“Such a strategy has not been forthcoming to date. The MTBPS [medium term budget policy statement] represents a further step towards developing one. It broadly quantifies the R150 billion (3% of 2019 GDP) additional cost saving measures that will be needed to balance the main budget net of interest and support to Eskom by fiscal 2022, its fiscal target, and stabilise government debt.
“[The MTBPS] does not yet identify what those measures will be, other than that they will focus on containing the public sector wage bill. The MTBPS also reiterates that additional operational and financial reforms will be needed to curb the drain on public finances from Eskom and SOEs in general.
“In short, this week’s [MTBPS] announcements do not yet represent a developed, credible fiscal strategy. The development of a credible fiscal strategy to contain the rise in debt, including in the 2020 budget process and statement, will be crucial to sustain the rating at its current level.”
Moody’s said its Baa3 rating affirmation for South Africa takes into account the country’s deep, stable financial sector and robust macroeconomic policy framework, set against ongoing challenges related to weak potential growth and strong fiscal pressures.
It said, explaining the rationale for its decision, that socio-economic features in South Africa including structurally high unemployment and income and wealth inequality are longstanding and deeply-entrenched constraints on the country’s growth potential.
“Deep inequalities — South Africa’s income inequality is among the highest globally, as measured by the Gini index — and resistance to reforms from key stakeholders limit the government’s room to adopt and implement structural reforms.
“In the last two years, it has become increasingly apparent that those constraints are challenging the government’s ability to implement reforms that would durably lift growth, to an even greater extent than previously expected. Moody’s has revised down its medium-term growth projections to 1-1.5%, barely in line with population growth, from earlier expectations of a gradual pick-up towards 2.5-3%.
“Job creation remains a central problem, with unemployment at a multi-year high of 29% in the third quarter of 2019. Gross fixed capital formation has been contracting on a year-on-year basis since the second quarter of 2018, as private companies see limited prospects of an improvement in the business environment. Productivity, the level of output per worker, has remained stagnant, in contrast with the steady, even if sometimes limited, growth seen in other countries at similar income levels.”
Moody’s said the government has promoted a number of initiatives in response to these long-diagnosed issues. “However, its ability to implement those initiatives in a way which generates broadly-based sustainable growth has faced obstacles in part from outstanding vested interests, in part from the social and political challenge of imposing measures that are initially likely to be detrimental for parts of the population.
“For instance, while the new mining charter has finally been introduced, it is unlikely to boost the sector’s investment, with regulatory uncertainty persisting amid ongoing appeals against some provisions of the charter.
“The government has also introduced multiple initiatives in the labour market including the Youth Employment Service programme, but none on a scale likely to materially increase employment. Other politically and socially sensitive reforms such as land reform have seen slow progress given the government’s need to balance the social and political objective of allowing land restitution, including through expropriation without compensation, and the economic objective of preserving investor confidence.”
Moody’s said low growth is exacerbating the pressures on South Africa’s fiscal position. The government debt burden has risen further than was expected a year ago and will rise still more in the coming years.
“South Africa is one of the few countries globally where the average interest rate on government debt markedly exceeds — by an estimated 3 percentage points in fiscal year 2018 — nominal GDP growth. Given that condition, the government debt-to-GDP ratio will continue rising unless the government is able to generate large primary surpluses. The likelihood that it is able to do so has fallen materially.
“The above-inflation wage indexation agreement, which runs until fiscal 2020 (ending on March 31 2021), continued transfers to SOEs including the planned capital support for Eskom, and a fast-growing interest bill limit the scope for spending restraint. Meanwhile, acute financial stress for certain SOEs, including but not only Eskom, point to likely ongoing sizeable transfers and broader contingent liabilities for the foreseeable future.”
Moody’s says South Africa’s geographical location means the country is subject to frequent climate-related shocks such as droughts, which undermine the agricultural sector’s performance and have weighed on growth in recent years. “That said, the country’s economic diversification and sophisticated agricultural techniques mitigate the impact of environmental considerations on South Africa’s credit profile.”
It says “governance considerations are material to South Africa’s credit profile. South Africa’s ranking under the Worldwide Governance Indicators is in line with that of Baa3-rated sovereigns, and the strength of key institutions, in particular the South African Reserve Bank and the treasury, continue to support the rating.
“Set against those qualities, the broader erosion in institutional strength induced by the corruption of the Zuma administration is an important factor behind the erosion in South Africa’s credit profile in recent years. The legacy that era has bequeathed of poor governance of SOEs, and of Eskom in particular, remains a key drain on fiscal resources and also weighs on South Africa’s fiscal strength.”
The treasury said in its response to Moody’s that it and the department of public enterprises “are instituting a series of measures to bring discipline to Eskom’s finances, encourage it to run its power stations better, improve operational efficiencies and to step up the timelines for restructuring the business into three entities to facilitate transparency, cost efficiencies, optimal investment in infrastructure and improved operational efficiencies.
“Following the release of the Eskom Special Paper on 29 October 2019, most operational changes are expected to be implemented before the end of 2021.”
What could change the rating up?
A rating upgrade is very unlikely in the near future. Moody’s would likely change the rating outlook to stable if it were to conclude that the government will succeed in stabilising its debt ratios over the medium term, by reining in expenditures, improving tax compliance and by lifting potential growth.
Moody’s will have regard to a number of factors in this respect, including the government’s progress early on in its tenure in delivering the additional fiscal adjustments which the MTBPS identifies are needed, but also in addressing long-standing issues related to corruption and the financially weak SOEs sector, and in particular at Eskom. If achieved, these should ultimately enhance business confidence and private sector investment prospects.
What could change the rating down?
South Africa’s ratings would likely be downgraded were Moody’s to conclude that those conditions will not be met and that South Africa’s fiscal and/or economic strength will continue to erode. Ultimately, this conclusion would likely reflect diminishing prospects that growth will be sufficient to preserve current income levels for the majority and halt the rise in government debt over the medium term. Signs of diminishing resilience to external financing shocks would also exert downwards pressure on the rating.
More immediately, a decision to downgrade the rating would reflect growing clarity that the government will not be able to further develop and implement its fiscal and economic strategy to halt and ultimately reverse the debt trajectory. The 2020 budget in particular will be a key indication in Moody’s view of whether or not the government is committed to the fiscal consolidation recommended by the MTBPS. — Moody’s Investor Service