8 factors pointing to lower chances for SA downgrade this year
South Africa’s chances for a credit rating downgrade to “junk” status (or below investment grade) at the end of 2016 have diminished since June, when the global credit rating agencies last conducted their reviews. Although the risk still remains high, this improving outlook can be attributed to positive developments both offshore and locally in recent months
- South Africa’s growth outlook has improved slightly. GDP growth for the second quarter of 2016 came in at a stronger-than-expected 3.3% (q/q annualised), following the -1.2% recorded in the first quarter. This avoids a technical recession, defined as two consecutive quarters of negative growth. The South African Reserve Bank (SARB) has revised upward its forecast for 2016 GDP growth to 0.4% from 0.0%, while raising its 2017 expectations to 1.2% and 1.6% in 2018. Although these are marginal improvements, growth is one of the major factors used by the ratings agencies in making their decisions. The SARB projections are now slightly higher than Moody’s own GDP growth forecasts of 0.2% in 2016 and 1.1% for 2017.
- Consumer inflation has fallen, interest rates have not risen. August CPI fell to a lower-than-expected 5.9% y/y from 6.0% y/y in July and 6.3% y/y in June, and is now within the SARB’s 3-6% target band. In its September interest rate decision, the SARB revised downward its inflation forecasts for 2016 and 2017, and cited this as one of its reasons for leaving interest rates unchanged. The SARB Governor also signalled that the rate hiking cycle may be nearing an end. With the SARB able to leave rates on hold, rather than hiking them as previously expected in June, the economy has more room for further growth.
- The rand has strengthened, the current account deficit has narrowed. Despite political uncertainties around Finance Minister Pravin Gordhan’s future arising from the Hawks’ investigation, the rand has improved versus the major currencies since June, thanks to renewed global investor appetite for South Africa’s relatively higher-yielding assets. At the beginning of July it was trading at R14.6 per US dollar and R16.3 per euro, versus R13.5 and R15.2 currently. This has helped reduce inflationary pressures in the economy. Also relieving pressure on the currency was the significant narrowing of the country’s current account deficit, to 3.1% of GDP in the second quarter from 5.3% in the first quarter.
- Global interest rates have remained low. With the US Federal Reserve leaving its interest rates on hold since June, adopting an accommodative stance toward growth and inflation, and Europe and Japan lowering their interest rates further, investors have continued to look for yield. This has supported emerging market assets and currencies like the rand.
- Business and government leaders continue to work together. Better cooperation between business and government leaders has continued in recent months. There have been concerted efforts to create growth and job opportunities and avoid a downgrade.
- Moody’s has put the chances of a downgrade at around 33%. The ratings agency currently rates South Africa the highest of the three global ratings agencies, at two levels above sub-investment grade, one notch higher than both Standard & Poor’s and Fitch. Moody’s will announce its decision on 25 November, while S&P, which has a negative outlook on its rating for South Africa, is set for 2 December. Fitch will conduct its review in early December.
Markets are reflecting the improved outlook. The premium on South Africa’s 10-year US dollar bond yield over the 10-year US Treasury bond (indicating the compensation demanded by investors to take on extra risk for lending their money to the South African government) has dropped sharply, and the South African government was able to borrow US$3 billion in global markets at the end of September for very low interest rates. These indicate that investors are more sanguine about the risk involved in lending to South African borrowers, and therefore about the risks of a credit rating downgrade.
These improvements have supported Prudential Investment Managers’ long-held asset class views. They have benefitted our fund returns during the third quarter of the year, given that we have been overweight bonds in our multi-asset portfolios for some time now.
Going forward, much more work needs to be done in order to ensure that South Africa maintains its investment-grade credit rating. Besides ongoing improvements in the above factors, the ratings agencies will also need to see more growth-enhancing structural reforms, such as those to make the labour market more flexible, as well as ongoing commitment to stick to the debt reduction targets in the Budget. Political uncertainty around the Finance Minister also needs to abate. In the absence of these factors, the risks of a credit rating downgrade remain very real.