/ 6 May 2016

Credit ratings: It’s tough, but SA’s hanging in there

Credit Ratings: It's Tough, But Sa's Hanging In There

You’d be unlikely to want the job of finance minister or South African Reserve Bank governor these days as the credit ratings agencies circle, inflation grows and the currency remains at historical lows. 

As if that were not enough to deal with, you may also have to endure persistent questioning from the Hawks, or worry your job could be offered to your deputy by a politically connected family. Meanwhile, state-owned companies increasingly behave as if they own themselves.

But incumbents Pravin Gordhan and Lesetja Kganyago last week showed that it is business as usual for them as they go about getting government business in order.

Gordhan, the finance minister, in his budget vote speech last week reiterated the need to cut down on spending and to stimulate growth. It’s everything the ratings agencies want to hear as they review their credit rating for South Africa this month – but the Reserve Bank, in its financial stability report, reckoned there was a medium to high risk of a downgrade to junk status.

In his Wednesday speech, Gordhan said that, although gross tax revenue in 2015-2016 met the 2016 revised target, it was in fact R11.3-billion lower than the original 2015 budget estimate. Pressure could, however, be taken off the fiscal deficit by cost-cutting.

“Measures to avoid unnecessary purchases, reduce waste and to contain costs continue to be prioritised,” Gordhan said.

A review of top contracts is expected to save R1.4-billion each year, and tightening around government travel should save R1-billion. A review of mobile and fixed telecommunications services could potentially save R500-million a year and a renegotiation of government leases is expected to save R2.8-billion in the next three years. Government’s procurement office is expected to save R25-billion each year by 2018-2019.

Responding to debate on the budget vote, Gordhan said there was a new tendency for boards of state-owned entities to do “things they are not supposed to do” and beginning to display a level of “arrogance and belligerence”. He was responding to a question specifically about Denel, which has come under fire from Treasury for going ahead with a Gupta-linked joint venture in Asia without the permissions required from the treasury.

Political turmoil has continued to weigh on the economy as numerous accusations of “state capture” by the Gupta family (believed to be close to President Jacob Zuma) surfaced. Following the withdrawal of banking services to the Guptas, the Reserve Bank resisted calls that it should investigate relationships between the commercial banks and the family because it was “not in a position to get involved in differences between banks and their clients”.

In the Reserve Bank’s Financial Stability Review — the first edition of 2016 — released last week, it said financial markets in South Africa had suffered two incidents of extreme volatility of late. The first was in December 2015 when the minister of finance, Nhlanhla Nene, was unexpectedly replaced, causing a significant sell-off in South African financial assets.

Then financial conditions deteriorated even further in January 2016, when emerging-market currencies in general, and the South African rand in particular, depreciated sharply as a result of strong data from the United States and concerns about China’s economic growth prospects, among other reasons.

Since the latter part of 2008, total loan debt of national government has maintained a gradual upward trend, the review said.

The annual growth rate of government debt continued to moderate, but the total loan debt of national government as a percentage of GDP still increased to 50.1% in the fourth quarter of 2015.

In view of fiscal sustainability and faster fiscal consolidation, government expects this debt as a percentage of GDP to stabilise at 46.2% in 2017-2018 and to reduce the budget deficit from 3.9% at the start of 2016 to 3.2% and 2.6% of GDP in the following two fiscal years.

“For more than a year credit rating agencies have been concerned about South Africa’s rating,” the review said. “Persistent weak economic fundamentals, the current-account deficit, budget deficit and other structural constraints led to a downgrade in the economic outlook for the country to negative. Although the 2016 budget speech ensured the continuation of fiscal discipline, rating agencies are still concerned about the implementation of the measures outlined in the speech.”

Global risks rotated to emerging markets during 2015 as a result of mounting credit and liquidity risks, and generally lower risk appetite, the review said. As a result, sovereign credit default swap (CDS) spreads of emerging markets increased sharply, particularly after Standard & Poor’s downgraded Brazilian bonds in September. (CDSs act as a sort of insurance in the event of payment default.)

This was also the case for South Africa, Turkey and Russia. Only South Africa’s CDS spread has outpaced those of most emerging-market countries since late last year, the Reserve Bank noted.

In the two weeks following the downgrade, the Brazilian real depreciated by almost 10% and the 10-year government bond yield increased by about 200 basis points to almost 17%.

The Reserve Bank said the impact of a further ratings downgrade on the South African economy and financial system could manifest in the form of capital outflows; potential spillovers to rand-denominated South African government debt; higher cost of and reduced access to funding; reduced credit to the private sector; increasing CDS spreads; receding business confidence; falling corporate profits; high and rising household debt levels and financing costs thereof; and elevated credit risk of financial and nonfinancial sector.

The Reserve Bank also said in its review, however, that a stress test carried out on the banking sector — using a scenario that included a credit rating downgrade to junk — showed that banks could withstand significant credit losses, even without taking into account any mitigating action by bank management.

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