S&P Global Ratings’ analysis, though fair and balanced, makes for sobering reading.
Released on Friday, the report gives credit where it is due, acknowledging the positive effect of the commodity boom on South Africa’s fiscal position, the country’s flexible currency and deep capital markets as well as the potential for reforms to lift its growth rate. But the ratings agency refuses to buy the government’s line on debt stabilisation.
It also worries that downside risks could be worsened by ongoing domestic electricity and infrastructure constraints along with a sharper economic slowdown in China and the rest of the world.
In contrast to finance minister Enoch Godongwana’s upbeat medium-term budget policy statement (MTBPS) last month, S&P takes a conservative view of South Africa’s fiscal outlook and highlights the downside risks to growth from both external and domestic factors.
Though both the ratings agency and the government expect the country’s economy to grow by about 1.6% on average over the medium term, S&P’s views on the likely path of the debt trajectory diverge markedly from the National Treasury’s.
S&P expects budget deficits to remain elevated, narrowing only slightly from about 5% now to 4.6% of GDP by fiscal 2025. The government expects the deficit to narrow faster, to 3.2% of GDP over the same period.
Likewise, S&P expects the gross debt-to-GDP ratio to keep climbing from about 71.5% now to almost 79% by fiscal 2025, while the government expects it to track downwards to 70%.
There are three main reasons for this divergence.
First, S&P assumes lower revenue growth than the government because of its expectation that global metals and most other commodity prices will trend lower. Second, it expects at the same time that spending will likely exceed official projections, leading overall debt to rise. Third, in line with the government’s recent undertaking to assume up to two-thirds of Eskom’s debt, S&P takes R250m of the power utility’s debt onto the government’s balance sheet next year, equal to 3% of GDP, which bumps up the debt ratio even further.
Perceived levels of corruption are high, and there is reduced predictability of future policy responses due to parts of the population desiring more economic participation and land
— S&P Global Ratings
S&P highlights four main risks to the expenditure outlook: that public sector wages will settle higher than now provisioned; that the social relief of distress (SRD) grant of R350 a month will be further extended or made permanent; that weak state-owned enterprises (SOEs) will require further government support; and that borrowing costs will be higher than projected.
It says annual wage negotiations with unions, the threat of disruptive strikes, and the general elections in 2024 “create significant uncertainty around the medium-term wage bill”.
It points out that the SRD grant has been extended a third time, to the end of fiscal 2023, and believes, like most local political and economic analysts, that “political pressure will likely make it a permanent feature of the budget in some form”.
Moreover, despite the government’s stance to limit support to SOEs, S&P expects that higher transfers are likely, given the weak financial and operating performance of several economically critical entities.
“These additional costs could overrun the government’s contingency reserves and unallocated reserves in the MTBPS,” it warns.
When it comes to economic growth, S&P agrees with the National Treasury’s forecast that real GDP growth will average 1.9% this year.
After a stronger than expected first quarter as the economy recovered from the pandemic, growth contracted by 0.7% in the second quarter, due to escalating energy shortages, logistical shortfalls — including lack of railway capacity and security incidents — and floods.
S&P expects these ongoing supply-side issues, coupled with recent strikes across several sectors, to weigh on the economy during the second half of the year.
Next year, the global environment will be less supportive for South Africa, with key export prices falling and global demand being lower, S&P says. It expects South Africa to grow by 1.5% next year, assuming a broadly similar level of energy shortages occur.
However, in a potential downside scenario, it warns that growth could slow to as little as 0.6% in 2023 and 1.1% in 2024.
This could, for example, result from a steeper global economic downturn, a deeper than expected recession in the US and Europe and a sharper slowdown in China. It could, in turn, worsen the funding environment and growth outlook for emerging markets, including South Africa.
In this event, S&P could revise the outlook on South Africa’s BB- foreign currency rating (and BB local currency rating) down from “positive” to “stable”.
It could also revise the outlook to stable if the expected debt transfer from Eskom to the government’s balance sheet significantly weakens the sovereign’s fiscal trajectory without addressing Eskom’s operational and financial shortcomings.
It expects that the government will largely offset the higher debt-servicing costs incurred through absorbing some of Eskom’s debt by reducing or eliminating planned fiscal transfers to the utility. But this doesn’t mean Eskom won’t continue to require additional government support to meet its maintenance and investment plans and immediate liquidity gaps, warns S&P.
“The broader impact on the fiscal position and the economy will depend on the government’s and Eskom’s ability to restructure the company’s operations and finances and the energy sector more broadly, thereby reducing government transfers to the entity,” it says.
Moody’s made a similar point after the MTBPS, noting that while the debt transfer will support Eskom’s financial sustainability, it will not alone resolve the general maintenance and operational challenges in the energy sector, which it expects to remain a drag on the economy.
Moody’s rates South Africa’s foreign currency debt as Ba2 — one notch higher than S&P does, on a stable outlook. It was also expected to issue a rating review over the weekend, but sat out this round, having issued a comprehensive critique of the medium-term budget.
Like S&P, Moody’s expects South Africa’s fiscal consolidation to proceed slightly slower than the government’s forecasts because it expects higher spending pressures and more constrained economic growth, with real GDP ranging from just 1%-1.5% over the next few years.
Surprisingly, Moody’s still expects the consolidated debt ratio to decline gradually from about 75% now (including all government guarantees to SOEs) to about 72% by 2025.
In its latest review, S&P has affirmed SA’s credit ratings, forecasting slow growth with some reform. But it has refused to buy the government’s line on debt stabilisation
— What it means:
Despite its concerns, S&P remains constructive about South Africa overall.
It has retained its positive outlook on the country’s ratings in the belief that the implementation of some structural reforms could ease fiscal and economic pressures and that the country will stay the course on fiscal consolidation.
“Though power and logistical bottlenecks continue to weigh on the economy, we expect that government measures to increase private sector activity and reform some key government-related enterprises could support stronger growth outcomes over the next two to three years,” it concludes.
Specifically, it singles out the potential positive effects of government measures to increase renewable electricity generation and to corporatise the ports and railways.
Should South Africa manage to sustain economic growth and fiscal consolidation against a backdrop of structural and governance reforms and supportive external sector dynamics, S&P says it could even upgrade the ratings by a full notch.
However, if its forecasts are anything to go by, the agency isn’t particularly hopeful in this respect. For instance, it expects the ratio of fixed investment to GDP to remain almost static over the medium term, at about 15.6% of GDP from 15.2% now. It also expects the unemployment rate to improve only slowly, from 33.9% this year to 32% by 2025.
Another key metric for S&P is real GDP per capita. It expects this to rise from $6,700 this year to $6,900 by 2025. Though a significant improvement from $5,700 in 2020, this would still be lower than the $8,900 South Africa recorded in 2011 and than several of its emerging-market peers.
Real GDP per capita growth, having been negative for much of the past decade, is forecast to come in at 1% this year but then hover around 0% over the medium term. That’s a worrying prospect, because if GDP per capita continues to stagnate it’s highly unlikely that the country’s fiscal position will improve sustainably.
S&P rates South Africa’s institutional quality fairly poorly, with a score of 4 on a scale of 1-6 (where 6 is the weakest).
Though it points to the country’s independent judiciary, free press and deep financial markets, it says: “Perceived levels of corruption are high, and there is reduced predictability of future policy responses due to parts of the population desiring more economic participation and land.”
In addition, it warns that, over the medium term, “social pressure will remain high, given growing public discontent over high unemployment and inequality and weak delivery of basic services”. And it says “funding requirements for new policy priorities and redistribution could weaken support for sustainable public finances and undermine economic growth”.
Responding to the ratings action, the National Treasury reiterated that the government’s strategy prioritises the achievement of fiscal sustainability; increasing spending on security and infrastructure to promote economic growth; and reducing fiscal and economic risks, including through supporting key SOEs and by building fiscal buffers against future shocks.
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