From Cabinet reshuffle to junk status in just 90 hours

It took just 90 hours after President Jacob Zuma axed Pravin Gordhan as finance minister for South Africa’s credit rating to be downgraded to junk status for the first time in 17 years.

The national treasury, steered by Gordhan, had made a concerted effort in the past 15 months to keep a dreaded ratings downgrade at bay but on Monday evening – almost four days after Gordhan was fired – Standard and Poor’s Global Ratings (S&P) announced that South Africa’s long-term foreign currency sovereign credit rating would be downgraded to sub-investment grade or junk status. The local currency rating was also cut, but remains one notch above junk. S&P’s outlook on both ratings is negative.

The blame, the agency said, lay squarely with Zuma.

“The downgrade reflects our view that the divisions in the ANC-led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk. This has increased the likelihood that economic growth and fiscal outcomes could suffer,” S&P said in a statement released as markets closed in the UK. 

“The rating action also reflects our view that contingent liabilities to the state, particularly in the energy sector, are on the rise, and that previous plans to improve the underlying financial position of Eskom may not be implemented in a comprehensive and timely manner.”

S&P added that higher risks of budgetary slippage will also put upward pressure on South Africa’s cost of capital, further dampening already modest growth.

“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.

In a statement from the treasury an hour after the news broke, S&P said that while it has lowered its rating of foreign currency-denominated debt to sub-investment grade, the local currency rating, or rand-denominated debt, constitutes 90% of the debt portfolio and retains its investment-grade rating.

On Friday UBS said the downgrade of South Africa’s local currency rating would see it ejected from a key bond index and trigger outflows of $10-billion, and doubling South Africa’s current account deficit. The local currency rating is now one notch away from junk status.

Said the treasury: “This rating announcement calls for South Africans to reflect on the need to sustain and act with urgency to accelerate inclusive growth and development so that we can reverse the triple challenge of poverty, unemployment and inequality. 

“Reducing reliance on foreign savings to fund investment and relying less on debt to finance public expenditure will secure South Africa’s fiscal sovereignty and economic independence.”

The new minister of finance, Malusi Gigaba had earlier on Monday, referring to his replacing of Gordhan, said changing an individual was unlikely to trigger a ratings downgrade.

A junk, or sub investment grade, credit rating means the country is viewed a higher risk by investors, and so the cost of borrowing to such a nation increases.

The South African government’s bench mark 10-year bond yield jumped from 8.97% to 9.12% within minutes of the news, extending a trend of growing cost of borrowing first triggered by the announcement that Gordhan would be replaced with Gigaba. Junk status rated countries Russia and Brazil have 10-year bond yields of 7.94% and 10% respectively.

The rand has continued to slide, reaching 13.67 to the dollar, an hour after the news of the ratings downgrade broke. Before rumours about Gordhan’s axing began to stir last Monday, the currency was at 12.20 to the dollar.

Raymond Parsons, economist at the North-West University School of Business and Governance, said the possible “domino effect” of the S&P investment downgrade of South Africa’s sovereign risk implies eventual higher borrowing costs for both public sector and private sector borrowing.

“This in turn will have a negative impact on South Africa’s growth prospects, investor confidence and job creation at a time when the country has been looking forward to an improved economic performance in 2017. It was also hoped the South African interest cycle had now at last peaked,” said Parsons. 

“The S&P decision also heightens the level of policy uncertainty which has hampered private fixed investment to date.

S&P may only deviate from its announced calendar for ratings decisions in limited circumstances. 

“In this case, the reasons for the deviation are the heightened political and institutional uncertainties that have arisen from the recent changes in executive leadership,” the agency said.

It said it could revise the outlook from negative to stable if it saw political risks reduce and economic growth and/or fiscal outcomes strengthen.

Gigaba is expected to address media on the downgrade on Tuesday. 

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