|Nhlanhla Nene, South Africa’s recently appointed minister of finance|
South Africa’s economy is arguably at its most vulnerable since the end of apartheid. Cyclically, South Africa is in the line of fire amid weak sentiment towards emerging markets and lower commodity prices, as well as the threat of portfolio outflows as a Fed rate hike draws near.
However, the country faces structural challenges too, amid weak growth, rising public sector leverage and a gaping current-account gap at 6% last year. For the past three years, rating agencies have downgraded the sovereign, with Standard & Poor's (S&P) the most bearish agency with a BBB- rating, one notch above junk, with a stable outlook.
South Africa is rated Baa2 by Moody’s, with a stable outlook, and BBB by Fitch, with a negative outlook. Without an improvement in the external climate or a policy shift, some analysts suggest its creditworthiness could fall to junk over the next year.
However, in a wide-ranging interview with Euromoney, Nhlanhla Nene, South Africa’s recently appointed minister of finance, remains unfazed by such a threat.
“The threat of a downgrade – well that is the prerogative of ratings agencies,” he says. "In any case, it’s very difficult to work towards protecting yourself from a downgrade. This isn’t – and shouldn’t be – our main focus.
“What we have aimed for in our latest package is intended to rebalance our finances such that we are able to deal with the challenges that South Africa faces today. We need to focus on growing our economy, protecting the poor while pulling them out of poverty, and dealing with inequality."
Nene adds: "Then, if we are able to do this, we will have a sound economy which investors and rating agencies will be drawn to. It shouldn’t be the other way around.”
Mining strikes led by disgruntled workers last year and rolling blackouts due to the failing state-owned energy company Eskom have seen expectations for GDP growth fall from 2.5% in last year’s medium term budget to 2% for 2015.
Meanwhile, unemployment levels are high: 24% of the 53 million population remain out of work. Young people fare the worst with 60% of people aged between 15 and 24 unemployed.
During the next three years, the government’s gross debt stock is projected to rise by around R550 billion to R2.3 trillion and redemptions will add R190 billion to the medium-term borrowing requirement.
A rating downgrade to junk would be a blow to the country’s reputation and underscore the poor health of its economy relative to its Brics counterparts. Institutional investors, in theory, could be forced to drop South African government debt, in line with their mandates, and the country's cost of borrowing would in all likelihood increase.
|Emerging market debt:|
Punishing original sin
Nevertheless, the country's well-developed local capital markets are a mitigating factor.
“As it stands, South Africa’s local currency rating stands at two notches above its foreign currency rating,” says Ravi Bhatia, South Africa primary sovereign analyst at S&P. "The local currency rating is important because South Africa has a large rand debt market with sizeable foreign participation in it.
“South Africa relies quite significantly on foreign portfolio flows. But while FDI flows to the country are sticky, portfolio flows are much more volatile.”
As laid out in the recent budget, Nene hopes to bring the budget deficit down to 2.5% by 2017 from 3.9% this year – which has already been revised upwards from 3.6% since the medium-term budget announcement in October.
The country’s expenditure ceiling is planned to drop by R25 billion over two years from levels set in 2014 and tax revenue is predicted to rise by R17 billion. Debt to GDP, which has been on an upwards trajectory since 2010, is hoped to plateau in two years’ time to 45%.
“The budget in February built on but maintained the core points of the medium-term budget announced in October,” says Nene. "And although between then and now the economic environment has deteriorated further, we have held the line.
“We have done everything we set out in the medium-term budget statement both on the revenue and the expenditure side, but we have also included issues regarding procurement and building efficacy in government departments, so we remain on track.”
S&P's Bhatia points out: “The budget was broadly in line with expectations, and the government has historically done well keeping control of expenditure. But part of the issue is on the revenue side, which is tied to the poor growth story. At the heart of improving metrics is good growth, but this currently isn’t the case in South Africa.”
“From an S&P point of view, however, it is important to note that our long-term foreign-currency sovereign credit rating for South Africa is BBB- with a stable outlook. Our next scheduled review is in June.”