Junk president. The cost of a downgrade

SA’s toxic politics has cost the country its investment-grade credit rating with S&P. Unless Jacob Zuma is stopped, multiple downgrades are likely to follow and the economy will face years of decline — if not a full-blown economic crisis and, ultimately, a debt default.

President Jacob Zuma’s craven attack on national treasury last week, by firing SA’s highly respected finance minister Pravin Gordhan, has set off a chain reaction he probably scarcely imagined possible. A week later: SA has a junk rating from Standard & Poor’s (S&P); there are ominous signs from Moody’s and Fitch; the market has tumbled; Zuma faces a backlash from civil society; and the ANC’s partners, Cosatu and the SA Communist Party (SACP), have asked him to quit.

Outrage is building within the ANC too.

In an unprecedented break from tradition, deputy president Cyril Ramaphosa called Gordhan’s firing "unacceptable", ANC treasurer-general Zweli Mkhize said Zuma’s actions sidelined the ANC, and secretary-general Gwede Mantashe said the new ministers seemed to have been picked "elsewhere".

By going for broke, an increasingly paranoid and isolated Zuma has emboldened and united his critics into defiance, forcing the fence-sitters and apologists in the ANC to finally take a stand.

If Gordhan’s firing isn’t the breaking point, S&P’s downgrade may just do the trick. Just before 5pm on Monday, after an emergency meeting, S&P cut SA’s long-term foreign currency rating to junk (BB+), and its local currency rating to just one notch above junk (BBB-), saying Zuma’s cabinet reshuffle had imperilled SA’s fiscal and growth prospects.

"The loss of investment grade will come as a further psychological blow to a country that has obsessed with the issue for years and will entrench a higher cost of offshore borrowing," said Rand Merchant Bank’s John Cairns.

In effect, Zuma’s reshuffle erased 17 years of fiscal and economic progress since S&P upgraded SA’s foreign currency rating to investment grade in 2000 — the first time since democracy in 1994. Now the country is back where it started.

Within hours of S&P’s move, Moody’s placed SA’s Baa2 ratings on review for a downgrade while it assessed whether Zuma’s actions would weaken SA’s institutional, economic and fiscal strength.

Moody’s review was only due on Friday April 7 but like S&P (whose review was expected only in June) it acted sooner, given the gravity of Zuma’s action.

"The economy now runs an increased risk of getting stuck in a prolonged period of stagnation, as SA could increasingly fall off global investor radar screens, given political and policy concerns amid a poorly performing economy," says Old Mutual Investments chief economist Rian le Roux. "SA has dealt itself a serious economic blow, something that may be hard to recover from."

It may have been expected, but the tumble into junk status still hurt, knocking the rand to R13,94/US$ at one stage on Tuesday — this after the reshuffle had wiped 10% off the currency last week, knocking it from R12.32 to R13.64.

Analysts say the reaction would have been a lot worse had the global environment not been so favourable to emerging markets.

S&P’s downgrade is likely to be followed by similar moves from Fitch and Moody’s, as all three ratings agencies have put great store by the importance of maintaining treasury’s institutional strength, given egregious examples of state capture and declining capacity in other parts of government. The fact that S&P retained its negative outlook on all SA’s long-term ratings is also alarming. It suggests it has little confidence that the ANC will rein Zuma in. "The negative outlook reflects our view that political risks will remain elevated this year, and that policy shifts are likely, which could undermine fiscal and economic growth outcomes more than we currently project," S&P said.

For Gordhan’s successor, the 47-year-old former ANC Youth League leader Malusi Gigaba, it’s been a baptism of fire. This has been made worse by questions over his credibility, because of his Gupta links.

Gigaba seemed shellshocked by the downgrade, saying "government’s overall policy orientation remains the same" and that he "remains committed to a measured fiscal consolidation that stabilises the rise in public debt".

S&P didn’t buy it. Says Le Roux: "SA has effectively labelled itself as a country that places little value on policy stability and predictability — key ingredients in making a country an attractive investment destination — and one where the political leadership is unconcerned with the economic fallout."

Over the past year, Gordhan was the bulwark against a downgrade, leading delegations of business and labour to New York and London to charm the agencies and woo foreign investors. Yet Zuma’s apparatchiks in the security services harassed him, threatening to arrest him on a bogus technicality last October. Zuma capped it all by ordering him back from an international investment road show last week, ostensibly based on a derisory "intelligence report". Sources say that when Zuma showed the report to Ramaphosa, he openly laughed at it.

Now with Gordhan out of the way, the fear is that economic reform will grind to a halt under Gigaba; state-owned companies will begin spending without restraint; and spending cuts won’t be implemented.

Unless, that is, the ANC can convince Zuma to go.

Zuma pulls plug on economic recovery; Gigaba perpetuates Zuma’s false narratives

Though Zuma seems unlikely to resign, he has never faced such a co-ordinated call for him to quit from inside the ANC and its alliance partners. This week, former president Kgalema Motlanthe told Bloomberg that Zuma was "reckless" and had no clue how his actions affect credit ratings.

"He doesn’t come across as someone who thinks about what is in the national interest or what is in the organisational interest, but seems to be driven by an agenda based on vested interests," he said.

This isn’t contradicted by Zuma’s reasons for axing Gordhan. Insiders say Zuma wanted Gordhan removed because of treasury’s reluctance to honour his nuclear deal with the Russians, its attempt to rein in Tom Moyane, Zuma’s point man at the SA Revenue Service (Sars), and its unwillingness to solve the Guptas’ banking woes.

At the memorial service for struggle stalwart Ahmed Kathrada last week, speaker after speaker spoke of "reclaiming the ANC" amid a sea of posters in the Jo’burg City Hall reading: "Zuma must go". Gordhan urged party activists to mobilise support to deal with the current challenge (read: Zuma), while Barbara Hogan, Kathrada’s widow, said: "You have sacrificed everything on the alter of greed and corruption ... Mr President this country is not for sale."

Zuma’s craven efforts to protect the Guptas were hinted at by axed deputy finance minister Mcebisi Jonas, who said "connect the dots ... If you look at everything in SA in the last few years, there is a certain pattern. Events point to particular interests being protected and consolidated."

Zuma is more isolated than ever.

Last Thursday, at a meeting of the top officials before his fateful decision, he was supported by only one of them — deputy secretary-general Jessie Duarte. Baleka Mbete was in Bangladesh at the time and Ramaphosa, Mantashe and Mkhize disagreed with Zuma. He is, of course, backed by the ANC’s youth and women’s leagues, its Mpumalanga chair David Mabuza and the MK Military Veterans Association.

Even the once-cowed business sector is speaking out. Roger Baxter, CEO of the Chamber of Mines, said Gordhan’s axing was unacceptable and that "the mining industry believes the changes will lead to instability and reduce investor confidence".

Standard Bank joint CEOs Sim Tshabalala and Ben Kruger were "dismayed" by the dismissal of Gordhan and Jonas. "This is a bitter blow, but there is work to be done. While it’s turbulent, I still have faith and hope that this great democracy will carry us through," Tshabalala said.

Brian Joffe, founder of Bidvest, said: "What was happening behind the scenes by many in government previously, is now out in the open. This will hasten change, in my view."

Arnold Goldstone, Invicta executive vice-chairman, said the company would "consider where we invest our funds very carefully ... I am very worried about my country."

To David Frost, CEO of the Southern African Tourism Services Association, a downgrade meant "the cost of capital will rise, creating the danger that big investors in the tourism industry will look elsewhere for opportunities."

Spur CEO Pierre van Tonder said the company would be "far more cautious" in investing and foresees "more upward pressure on food prices coming".

Nedbank CEO Mike Brown said: "Ratings agencies will be concerned, as we are, about the slow growth in the economy and the fact that government is spending more money than it collects in taxes, leading to an increase in government borrowing."

The CEO Initiative, which represents top executives of all SA’s major corporations, blamed Zuma, saying the downgrade "could and should have been avoided had the structural reforms necessary to underpin sustained and inclusive economic growth been implemented".

S&P, too, said the reshuffle had jeopardised policy continuity and was a threat to growth. Fitch said Zuma’s actions "signalled a change in policy direction that would potentially weaken SA’s public finances and standards of governance".

Moody’s could downgrade SA if it concludes that recent events signal a "deterioration in the effectiveness of government or in the credibility of policymaking".

Zuma defenders climbed into the ratings agencies. The Gupta-owned ANN7 ran a series of crackpot reports titled "S&P doesn’t give Gigaba a chance". "Does S&P’s move create further suspicion on the real motive for Gordhan’s meeting with credit agencies in the UK?" it asked.

Gordhan compared ANN7’s reporting to the tactics of Adolf Hitler’s propaganda minister, Joseph Goebbels.

The ratings agencies, in asking for sound macroeconomic fundamentals and pro-growth reforms, want no more or less than SA citizens should be demanding.

Their concern is the sustainability of debt and the inability of the economy to grow at rates needed to raise living standards and create jobs. Zuma, by pulling the rug out from under treasury, has halted the fragile recovery that was peeping through after the end of the drought and the rise in global growth.

Instead of growth exceeding 1% (the prevailing consensus), SA now faces the prospect of another consecutive year of bumping along the bottom, with growth close to 0%.

The fallout from Gordhan’s sacking has been muted compared to the aftershocks of Nenegate. But should the pushback against Zuma fail, and a cascade of ratings downgrades follow, experts say the rand could fall beyond R16/$.

Some Zuma supporters believe a ratings downgrade harms only "white monopoly capital", but the opposite is true. A weak rand leads to higher inflation (as we import goods, especially oil for petrol), which leads to higher interest rates, hurts consumer spending and chokes investment.

Any nosedive in already shaky investor and business confidence is guaranteed unless Gigaba and his deputy, Sfiso Buthelezi, demonstrate independence from Zuma. If they do not do so, they will be seen as assets of his state-capture project.

Gigaba and Buthelezi are already on weak ground, due to their patchy track records in government, perceived links to the Guptas and loyalty to Zuma. And Gigaba knows next to nothing about fiscal policy.

On Saturday, he asked to be judged only by his actions. But then he repeated rather than repudiated the fantasy peddled by Zuma and his spooks that treasury had been "captured by big business" and was out of touch.

"There has been a narrative or perception around treasury, that it belongs primarily and exclusively to ‘orthodox’ economists, big business, powerful interests and international investors. With respect, this is a people’s government," he said.

Gigaba then held forth on how SA economic policies have failed to dent inequality because they’re not progressive enough.

Yet according to the World Bank, SA has had more success in using fiscal policy to reduce inequality and poverty than 11 peer countries, among them Brazil, Mexico and Argentina. In a 2014 study, the bank found that through the use of taxes and social grants which redirect resources from the rich to the poor, 3.6m South Africans had been rescued from poverty and SA’s income inequality had been reduced by 25%.

So, before taxes and social spending, the income of SA’s richest 10% was more than 1,000 times greater than the poorest 10%. But after these fiscal measures the gap fell to 66 times — a drop in SA’s income Gini coefficient from 0.77 to 0.59.

The real problem is that the quality of government’s spending and services, especially in health and education, is so low that though targeted at the poor, there is only a tenuous link between higher spending and better outcomes.

The scope for further redistribution is limited by SA’s small tax base, and by the extent of redistribution that has already occurred. This means the only sustainable way for government to improve the lives of the poor, apart from growth and job creation, is to improve the quality of public services.

At a time when state capture and corruption have hollowed out key institutions, there seems little chance of this happening.

The obvious solution is for government to rope in the private sector. Instead, in an effort to justify more aggressive redistribution, the Zuma faction has demonised the private sector by creating a false narrative of "white monopoly capital" and scapegoating treasury to justify axing Gordhan.

The bottom line: Zuma’s reshuffle will retard growth and job creation, making it harder to reduce inequality.

"Damaged business confidence will keep a lid on much-needed investment spending and economic growth will remain muted. The implication, in turn, for urgently needed job creation by the private sector, is unambiguously negative," says Citadel’s chief strategist, Adrian Saville.

Gigaba will be ring-fenced, at least initially, by seasoned treasury officials who will try to hold him to his pledge that he’s committed to maintaining SA’s investment-grade credit rating. But if key people leave, all bets are off. Already, on Tuesday, rumours surfaced that director-general Lungisa Fuzile planned to leave this month.

Gigaba will have to dampen the risks that are building, including ensuring an affordable public-sector wage settlement next year.

He will also have to tame the soaring contingent liabilities created by the failing state-owned enterprises (SOEs). These companies, led by Eskom, Denel and others, are racked by inefficiencies and poor procurement practices (many of which arose while Gigaba was public enterprises minister).

Already, SOEs have drawn down 65% of their total available pool of R478bn in government guarantees (up from 55% a year ago). The IMF estimates that in an "extreme" scenario where 75% of government’s guarantee exposure is realised, it will push state debt above 70% of GDP by 2021. This is the "high-risk threshold" often associated with debt distress in other emerging-market countries. These contingent liabilities have consistently been flagged by the ratings agencies. Now S&P has taken a closer look and its conclusions are alarming.

S&P estimates that SOEs will probably need almost R200bn more in extraordinary government support over the next three years. This would raise the state’s SOE exposure to R500bn by 2020 (or 10% of SA’s projected 2017 GDP), against R308bn now.

In other words, S&P expects 100% of the current government guarantees to SOEs to be used up by 2020 and then to keep climbing — a far worse outcome than the "extreme" example modelled by the IMF.

Fitch is equally concerned.

While Gordhan felt these rapidly rising contingent liabilities posed the gravest risk to SA’s fiscal position, Gigaba didn’t mention them once in his maiden speech.

And, if growth stalls or SA enters a recession this year, tax collections will plummet. The fear is that Gigaba will be unable to make unpopular spending cuts — which raises the prospect of more growth-sapping tax hikes.

Nomura economist Peter Attard Montalto feels SA is headed for "a profound economic and market shock" in the coming months as financial markets realise Zuma is not going to be taken down by the ANC’s reformists. Attard Montalto thinks Zuma remains on course to take control of the ANC presidency at the elective conference in December, through his ex-wife Nkosazana Dlamini-Zuma. Therefore, Nomura has lowered its 2017 GDP forecast for SA to 0.2% from 1.1%. It expects interest-rate hikes in May and for the rand to hit R15.50/$ by midyear, with multiple ratings downgrades.

Sanlam Private Investments CEO Daniël Kriel says the biggest concern is the potential loss of experienced staff at national treasury, similar to what happened at Sars. Sanlam has recommended to clients that they keep their portfolios diversified, with a substantial rand hedge while retaining its bank shares.

Regardless, investment risk has increased. Unless Zuma can be stopped, SA can expect investment and jobs growth to contract, per capita GDP growth to remain negative and social expectations to remain unmet. If Zuma’s new troops respond with further bungling and by ratcheting up their anti-white, populist rhetoric, it will only accelerate SA’s slide.

"It is now in the hands of civil society and our political leaders to pull SA decisively away from a situation that, if allowed to go unchecked, could potentially turn into a full-blown economic, political and social disaster," says Le Roux.

Whether it ends in a debt default depends on whether SA is able to step off this slippery slope before the bond market decides government can no longer service its debt.

A looming parliamentary vote of no confidence in Zuma, requested by the DA and EFF, is unlikely to unseat him.

And the ANC’s national executive committee seems unlikely to recall Zuma, as it did Thabo Mbeki in 2008. "It will weaken the ANC," said one MP opposed to Zuma’s leadership.

Sources said the ANC’s parliamentary caucus is angry at the position they’ve been placed in and many want to vote "with their conscience" to remove Zuma.

The ANC now has a choice, as SACP second deputy general secretary Solly Mapaila put it, between "Zuma and the people". If it chooses Zuma, it risks another electoral slide in 2019.

* Additional reporting from Moyagabo Maake, Adele Shevel, Charlotte Mathews, Stafford Thomas and Hanna Ziady