By Nazmeera Moola, Co-Head of SA & Africa Fixed Income, Investec Asset Management
Following Standard & Poor’s (S&P’s) downgrade of South Africa’s hard currency debt to BB+ on Monday night, Fitch downgraded South Africa’s local and foreign currency ratings from BBB- to BB+ today. Since S&P has retained the local currency rating above the investment grade floor at BBB-, Fitch now has the lowest combined rating of the three rating agencies on South Africa’s debt – and is the only rating agency to have SA’s local currency rating sub-investment grade.
Moody’s put South Africa on watch for a downgrade earlier this week, citing the recent cabinet reshuffle. However, it is waiting to see if the reshuffle results in substantial changes to key policy stances. Fitch – like S&P – decided that it did not need to wait to see if the stance changed. The last eighteen months had provided sufficient evidence for the rating agency that the personnel change was highly likely to result in policy change.
Fitch’s reasoning was very similar to that offered by S&P earlier in the week. Its accompanying statement was very direct, clearly stating that the reason for the downgrade was Fitch’s view that recent political events, including a major cabinet reshuffle, will weaken standards of governance and public finances. The three major factors it cited were:
- “The reshuffle is likely to undermine, if not reverse, progress in SOE governance, raising the risk that SOE debt could migrate onto the government's balance sheet.”
- “Under the new cabinet, including a new energy minister, the [nuclear] programme is likely to move relatively quickly.” This would significantly add to South Africa’s contingent liabilities.
- “Following the government reshuffle, fiscal consolidation will be less of a priority given the president's focus on ‘radical socioeconomic transformation’.”
Going forward, the agency will be monitoring the following factors for risk of a possible downgrade: a failure to stabilise the debt/GDP ratio, an increase in contingent liabilities, failure for growth to recover, rising external debt levels.
It also notes that there are key factors that could lead to an upgrade. These are an improvement in governance, better business confidence, a narrower budget deficit and an improvement in the external debt/GDP ratio. Essentially, Fitch is saying that if Finance Minister Gigaba delivers on the promises made in February’s Budget by then Finance Minister Gordhan, the rating would stabilise and could be upgraded.
Figure 1: South Africa’s credit ratings
|SA ratings||Foreign LT debt||Local LT debt||Outlook|
Source: Investec Asset Management, Bloomberg, 07.04.17
- Key developments to watch in the next few months:
- Moody’s will be releasing the result of its ratings watch in the next 90 days. It is likely to move both the local and foreign currency ratings to Baa3 (equivalent to BBB- at S&P), the lowest investment grade (IG) rating on its scale. More pertinently, it could also keep the rating outlook on negative – leaving South Africa at risk of moving below IG in the foreseeable future.
- For Moody’s to keep the rating unchanged at the current level, Finance Minister Gigaba would need to demonstrate that there has been no change in policy on any of the three factors Fitch cited above.
- If local currency ratings for both Moody’s and S&P soon fall to below IG, South Africa would exit the Citi World Investment Grade Bond Index. We estimate that forced selling in such an instance could amount to up to R120bn. Without any change in the current status quo, we estimate that S&P could move the local currency rating below IG by end-2017. Moody’s is likely to take longer.
- There is a real risk that some members of senior management at the National Treasury will resign in the coming weeks. We have already seen the Director General, Lungisa Fuzile, indicate that he will be leaving. We now need to monitor movements from the key people that serve under him. Since 1994, the National Treasury has become a formidable institution that has provided stability for South Africa through the Asian crisis in 1998 and the Global Financial Crisis in 2008. Institutions are only as strong as the people that lead and staff them. A significant loss of key people will undermine this institution completely.
- Market reaction to recent events that started with President Zuma’s reshuffle and the ensuing rating downgrades to sub-investment grade from both S&P and Fitch has been quite muted. This is due to two factors:
- Firstly, money is flowing into emerging market assets from around the world at this point – unlike the outflows we were seeing in December 2015 when Finance Minister Nene was removed. According to Goldman Sachs, emerging market debt and equity funds registered a combined $33.9bn worth of inflows in the first quarter of 2017. This is the largest first quarter inflow on record. That moderates any sell-off.
- Secondly, a large portion of foreign investors expect South Africa to use this crisis point to reform – much as Brazil did last year. If there is no sign of that reform coming, then investors will capitulate at some point in the coming months.
Investec Asset Management is responsible for the investment management of R1.6 trillion of client assets globally.
Nazmeera Moola oversees the investment management of R190bn of client assets as Co-Head of SA & Africa Fixed Income at Investec Asset Management.
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