/ 7 April 2017

Fitch becomes second agency to downgrade SA’s credit rating to junk

Fitch expects the South African economy to expand by 0.5% this year.
Fitch expects the South African economy to expand by 0.5% this year.

Fitch became the second ratings agency to downgrade South Africa’s sovereign credit rating to junk status this week.

On Friday it downgraded both South Africa’s local and foreign currency ratings, citing President Jacob Zuma’s Cabinet reshuffle and the increased likelihood that South Africa would speed up its “expensive” nuclear procurement drive under a new Cabinet.

The ratings agency said the replacement of former finance minister Pravin Gordhan and his deputy, Mcebisi Jonas, is likely to result in a change in economic policy direction.

The reshuffle reflected Gordhan’s efforts to improve governance at state-owned entities (SOEs) and would undermine, if not reverse, progress made in SOE governance, Fitch said. This would increase the risk that SOE debt could “migrate onto the government’s balance sheet,” it said.

Differences over the expensive nuclear programme may also have contributed to the reason for the recent reshuffle, Fitch said, and under the new Cabinet, including new Energy Minister Mmamoloko Kubayi, “the programme is likely to move relatively quickly”.

Eskom had already issued a request for information for nuclear suppliers and is expected to issue a request for proposal for nuclear power stations later this year, it added.

“The treasury under its previous leadership had said that Eskom could not absorb the nuclear programme with its current approved guarantees, so the treasury will likely have to substantially increase guarantees to Eskom,” the agency said.

Government guarantees to various parastatals are expected to reach over R460-billion in the 2017/18 financial year, according to data from the treasury.

Fitch’s announcement came as thousands of South Africans in cities across the country took to the streets to protest Zuma’s leadership.

The steady deterioration in South Africa’s foreign and local currency credit ratings is beginning to threaten its inclusion in important global bond indices, such as the Citigroup world government bond index (WGBI).

The foreign currency credit rating applies to the debt a country issues in a foreign currency. In other words, it is the agency’s view of the ability of an issuing country to meet its loan obligations in a foreign currency.

The local currency rating applies to debt issued in a country’s own currency.

According to the national treasury, South Africa has around R2.2-trillion in government debt, with about 10% (or R220-billion) in foreign currency, such as US dollars and euros. The rest is denominated in rands.

It is the local currency ratings of agencies Moody’s and S&P Global that determine whether South Africa will remain in the WGBI.

S&P downgraded South Africa’s foreign currency rating to sub-investment grade, while it kept the local currency rating a notch above junk, with a view to downgrading it.

Moody’s, which has placed South Africa on review for downgrade, but is yet to make a decision, currently has South Africa’s foreign and local currency ratings above junk.

Inclusion in global bond indices ensures that certain large investors, such as pension funds, who are mandated to only take up investment grade debt, can buy South African bonds.

According to KPMG economist Christie Viljoen, exclusion from these indices, would not necessarily be the “end of the world”. But remaining in them makes it much easier and cheaper for major international investors to buy government debt.

While 90% of government’s debt was rand denominated, international investors hold around 35% of that debt he added.

The steady downgrades of South Africa’s credit ratings to junk would worry these investors, he said, and will have implications for South Africa’s ability to raise money.

“The cost of future debt will become more expensive,” Viljoen said.

In a statement, the treasury said it noted Fitch’s decision and although it was “a setback”, government remained committed to working with business, labour and the civil society to improve “business confidence and implement structural reforms to accelerate inclusive economic growth”.

It reaffirmed the government’s commitment to the policy stance contained in Zuma’s State of the Nation Address and the 2017 budget.

This included the fiscal policy trajectory outlined in the budget; reforms to improve governance at SOEs and ensuring that nuclear procurement “will be transparent and implemented at a scale and pace that the country can afford”.