A year ago, after President Cyril Ramaphosa’s first state of the nation address, ratings agency Moody’s upgraded SA’s credit outlook from "negative" to "stable", and suggested the country may enter a virtuous cycle of economic growth, fiscal prudence and mounting social cohesion.
Both Fitch and S&P Global Ratings had junked SA’s rating in the first week of April 2017, immediately after the axing of former finance minister Pravin Gordhan, but Moody’s has kept SA’s ratings on the last rung of the investment-grade ladder all along.
This follows an established pattern: Moody’s has been inclined to give the country the benefit of the doubt despite repeated fiscal and growth disappointments.
In November 2017, S&P kicked SA deeper into junk territory after former finance minister Malusi Gigaba’s disastrous medium-term budget policy statement, but Moody’s put SA on a 90-day review to first assess the outcome of the ANC’s December elective congress.
When Ramaphosa was elected, Moody’s patience appeared to have been rewarded. Since then, its position has been that, under Ramaphosa’s leadership, institutions would be repaired and political and policy certainty would engender confidence, leading to a higher level of investment, a gradual economic recovery and the stabilisation of SA’s fiscal position.
Assuming the election fails to unleash bold pro-growth reforms and that Eskom stumbles along, then a junk rating from Moody’s is just a matter of time
Despite its optimism, Moody’s cautioned that SA’s challenges shouldn’t be underestimated. There were two possible routes SA could take, it said: a positive one in which "a virtuous cycle emerges of economic growth, fiscal prudence and mounting social cohesion"; or a more negative one in which policy ineffectiveness continues to undermine confidence, growth, social cohesion and the fiscus.
Unfortunately, SA is sliding towards the latter scenario. As Ramaphosa’s reforms have failed to gain traction and growth has stuttered — leading to repeated fiscal slippage — SA is fast running out of excuses and Moody’s out of patience.
In the aftermath of the grim 2019 budget, which Moody’s said revealed "a further erosion in SA’s fiscal strength", the ratings agency’s continued approbation hangs in the balance.
Moody’s no longer expects a marked acceleration in SA’s growth over the next few years. It is forecasting real GDP growth of just 1.3% in 2019 and 1.5% in 2020.
This is lower than the National Treasury’s estimates of 1.5% and 1.7%, but it may still be too optimistic if load-shedding is prolonged or attempts to restructure Eskom spark significant public protests.
About Eskom, Moody’s has been forthright: unless and until a clear adjustment path is detailed, the utility will remain SA’s main source of contingent liability risk and weigh on the country’s fiscal strength and credit rating.
So a big part of this year’s budget challenge was to convince Moody’s that the Eskom bailout would be credit neutral. The government did this by making the bailout contingent on measures to stabilise Eskom’s financial situation and by cutting expenditure elsewhere. Only, it failed to take SA into its confidence as to what this set of measures would entail other than dividing the power utility into three parts.
It will become clear when Moody’s publishes its ratings action on March 29 whether the government has done enough to convince it in private briefings that it has a credible turnaround plan for Eskom.
The fact that S&P upgraded the outlook on Eskom’s debt profile to "stable" from "negative" last week would seem to suggest there is grounds for optimism.
Economists are divided about what will happen next. Several expect Moody’s to downgrade the rating outlook from "stable" to "negative" on March 29 due to SA’s disappointing growth and fiscal performance. Others think it will wait to see what happens in the May elections and at Eskom, and then make a move at its November 1 review, pushing a potential junk rating into 2020.
Assuming, as seems likely, that the election fails to unleash bold pro-growth reforms and Eskom stumbles along, further depleting the fiscus, a junk rating from Moody’s is just a matter of time.
Many foreign investment mandates permit investment in SA as long as one of the three main ratings agencies maintains the country at investment grade. SA’s continued membership of the world government bond index (WGBI) requires that either S&P or Moody’s rate its rand-denominated debt investment grade.
This means that if Moody’s junks SA, there will be forced selling by foreign investors out of the local bond market — the main source of financial inflows in the past few years. SA’s exclusion from the WGBI could trigger capital outflows of about R100bn over several months, according to various estimates.
In theory, the rand would then plummet, causing inflation to rise and inviting higher interest rates. A junk rating would not only raise the borrowing costs of government and state-owned enterprises — it would also be more expensive for companies to do business and consumers would have less money to spend. Business and investor sentiment would take a severe knock.
All this would likely curb output, fan sociopolitical tensions and worsen SA’s fiscal position. It could quite plausibly precipitate a recession, in which case aggressive austerity measures would likely be required to ensure fiscal sustainability.
In April 2016, Standard Bank researchers predicted that if SA was junked, it would likely cause a recession lasting almost two years. This was based on the economic fallout in six of SA’s peer countries — Brazil, Bulgaria, Croatia, Hungary, Romania and Russia — when they were junk-rated.
However, when SA’s initial downgrade to junk by Fitch and S&P happened, market reaction was fairly tame. In nominal terms, the rand dropped by 12% to R13.83/$ in the first week, before pulling back sharply.
By comparison, after PW Botha’s "Rubicon" speech in 1985, in which he failed to announce the dismantling of apartheid, the rand nose-dived by 66%. In the 2002 rand crisis, it plunged by 47%, and in the month after former finance minister Nhlanhla Nene was fired in December 2015, the rand shed almost 17% to hit a worst level of R16.78/$.
However, at the time of Nene’s axing, China appeared to be heading for a hard landing. This worsened the growth prospects of commodity-producing countries such as SA, and caused persistent capital outflows from emerging markets (EMs).
Had the same global conditions been in place when Gordhan was axed, the fallout would likely have been more severe.
Instead, the positive outlook in advanced economies at the time contributed to a more favourable environment for EMs, and inflows into SA’s bond market held up well.
With EMs in a less favourable position now, and SA set to be ejected from the WGBI, one might conclude that the country will be much harder hit this time around.
"Not necessarily," says BNP Paribas economist Jeffrey Schultz. Though he expects SA’s currency, bond and credit markets to sell off significantly if Moody’s junks SA, much will depend on the behaviour of the US dollar.
"It’s our contention that the dollar is likely to weaken further in 2019 as the US economy begins to slow and the Fed takes its foot off the hiking pedal," he says. "In fact, we think that in this environment EM currencies like the rand actually stand to benefit."
A junk rating would dig SA deeper into trouble, but is unlikely to be a fiscal cliff event
— What it means
It also depends on the degree to which a junk rating by Moody’s is already priced into the markets.
Bureau for Economic Research chief economist Hugo Pienaar says the credit default swap market puts SA at a higher risk of a default than Brazil, which is already junk-rated by all three agencies. So on this measure, a full Moody’s downgrade appears priced in.
Also, much of the market reaction typically takes place in the run-up to a big downgrade rather than after the event. Judging from the R66bn selloff in SA bonds in 2018, this might already have started, though EM sentiment was also dampened last year by the travails of Turkey and Argentina.
The bottom line is that though being cut to junk will hurt SA, possibly severely, it won’t be a fiscal cliff event. The cost of borrowing will rise and life will become harder, but SA will still be able to borrow. After all, SA is a large market and other junk-rated EMs still attract foreign funding.
But this misses the bigger point: the need for the country to recognise that all the ratings agencies want is to be convinced that SA is putting in place the building blocks towards a durable fiscal and growth recovery. The fact that the country has not been able to convince two of the three — and looks set to lose the confidence of the third — bodes ill for its future.
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