Socio-economic challenges preclude South African upgrade in 2013


Matthew Turner
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Credit improvement hinges on stable policy environment

Labour unrest, sluggish economic growth and widening political divisions prompted Moody’s and Standard and Poor’s (S&P) to downgrade South Africa’s credit rating in 2012 – leaving it on the brink of junk status – while Fitch revised the sovereign’s credit outlook to negative, citing limited progress on policy reforms.

This year is therefore pivotal for the government to restore investor confidence in the country. Investors hope the government can initiate policies that will assist growth while enabling the country to consolidate its public finances. However, a weaker policy environment could prove to be a hindrance in putting the economy on the road to full recovery.

Weaker institutional strength was cited as a main driver in the decision by Moody’s to downgrade South Africa’s credit rating to Baa1 from A3 last year. The country’s institutional-strength metric was revised to moderate from high by the rating agency in October.

“The revision is essentially a downgrade in our appraisal of the authorities’ capacity to handle the current political and economic situation, and to implement the effective strategies that would put the economy back on the road to faster and more inclusive growth,” reports Moody’s.

The trend is reflected by analysts participating in Euromoney’s Country Risk survey, which shows that South African experts lowered their assessment scores for the country’s institutional risk indicator from 6.1 points in Q1 2012 to 5.8 points in Q4 2012.

This score decline leaves South Africa’s institutional risk in a relatively positive position in comparison to other middle-income countries, but further deterioration in South Africa’s institutional and policy environment could lead to investor confidence eroding in 2013.

National Development Plan

Against expectations, president Jacob Zuma, the National Executive Committee and all the delegates at the ANC leadership conference endorsed the National Development Plan (NDP).

Successful implementation of the plan would help pave the way for the government to reach its deficit-reduction targets and achieve greater policy uniformity in government and policy circles.

Kristin Lindow, an analyst at Moody’s, says: “A lack of policy coherence was one of the drivers for our rating downgrade in September last year. The NDP is an important policy proposal from government economic experts that calls for implementing structural reforms long resisted by politicians. We see the ANC’s broad support for the NDP – going all the way up to the top echelons of the party – as credit-positive.”

However, substantial implementation risk remains. The prevailing political environment is not conducive to unanimous implementation of the plan – the trade unions and some ANC delegates oppose the plan – and waning investor confidence could lead to a shrinkage of private sector contributions, needed for the plan to get off the ground.

Sluggish economic growth brings country’s performance under radar

Weakening external conditions for South African commodities added a strain on the economy’s growth trajectory in 2012.

The South African economy is expected to grow to 3% in 2013, according to the IMF, down from a July projection of 3.3%, while the IMF maintained its projection of 2.6% growth in 2012.

These growth rates are disappointing when compared with other emerging markets that lie alongside South Africa in Euromoney’s Country Risk rankings. For instance, Peru, ranked 49 in the rankings, is forecast to grow 6% in 2013, and Turkey, ranked 48, is forecast to grow 3.5% – leaving South Africa, ranked 50, to lag behind similar rated countries.

                                       source: Euromoney Country Risk

Lower investment and domestic saving rates contributed to sluggish growth in 2012, while high strike activity and further labour unrest disrupted production levels – a detriment to economic growth in 2012.

A report by Fitch notes the constraints on economic growth: “Estimates of potential growth have been revised down to around 4% and such a pace is unlikely to be achieved in the next few years without an acceleration of structural reforms. The employment rate is a low 40% and unemployment stuck at 25%. The political challenge presented by these issues will increase over time.”

Lindow adds: “The revenue picture has been disappointing in 2012 as private sector companies have sat on large cash reserves due to uncertainty over which way government policy would go, while the credit-fuelled consumer spending cycle has come to a halt. This has led to decreased tax revenues, raising suggestions that corporation tax rates may be increased in the February budget.”

Growth in the South African economy would therefore hinge on the lessening of strike activity and the global economic growth/recovery remaining on track. The eurozone remains a pivotal trading bloc for South African exports – as such, the growth in the South African economy will be dependent on the eurozone debt crisis remaining manageable.

Debt and contingent liabilities

Total government debt is forecast to climb to 42.3% of GDP in 2013, from an estimated 40.1% in 2012. This is comparable with 8.3% for Russia, 41.7 % for Thailand and 40.9% for Lithuania – all of which are rated Baa1 by Moody’s. While this rate is largely in line with other Baa1-rated sovereigns, further deterioration in the government’s fiscal position could prompt a credit rating downgrade.

                                  source: Euromoney Country Risk

Deteriorating tax revenues and a more negative investment climate are cited as reasons by Moody’s for the deterioration in the country’s fiscal position.

Therefore, further deterioration in the country’s fiscal position could hinder private sector investment, as they await more concrete policy proposals from the government in controlling the country’s deficit.

These developments have prompted the government to cut its spending in 2013: As Lindow says: “The government is well aware it is running out of fiscal space and has committed to lowering the growth of spending.

“The intention is positive but it is rather a question of implementation – whether the government can follow through on containing spending, as outlined in the last medium-term budget policy statement.”

Impact on credit rating

Addressing the widening socio-economic challenges effectively is critical if the government is to restore its fiscal credibility and retain an investment-grade credit rating.

Debt sustainability remains a forefront issue for the government, which requires the maintenance of sound economic policies to offset an accumulation of debt and contingent liabilities.

Restoring investment back to pre-crisis levels will help improve revenues. This will depend on the extent to which the government abandons nationalization plans of mines and endorses pro-active fiscal policies.

However, continued labour unrest and heightening socio-political tensions could offset any improvements made on the fiscal adjustment side. And there is still a substantial risk to South Africa’s credit rating in 2013.

This article was originally published by Euromoney Country Risk