Long road ahead for South Africa to climb out of junk status

South Africa’s credit outlook has brightened after the country lost its last remaining investment grade rating in 2020. 

Barring any big policy surprises, the country seems to have gained a strong foothold in its climb out of junk status. But there are still stumbling blocks standing in South Africa’s way, including persistently low growth and pressures to blunt the struggling economy’s blow on household finances.

On Friday, S&P Global is expected to give its assessment of the country’s sovereign credit rating. Analysts were also expecting Moody’s to give an assessment on Friday, but it has since clarified that it has no such plans. Fitch could also assess South Africa’s rating this month but, like S&P, it will probably hold out until the country’s fiscal trajectory is clearer.

Junk status

In 2020, when South Africa and the rest of the world were still reeling from Covid-19, the country was dealt a devastating blow when Moody’s downgraded the country’s credit rating to sub-investment grade.

The pandemic’s shock to the local economy was a big reason for the decision, which the ratings agency said would leave long-term scars on the country’s fiscal position. Economic constraints, such as low economic growth, predated the pandemic’s onslaught, which Moody’s said could hamstring structural reforms.

South Africa first felt the sting of junk status in 2017, when Fitch and S&P first downgraded the country’s rating to sub-investment grade.

Those decisions came in the wake of political ructions that culminated in president Jacob Zuma’s removing Pravin Gordhan as finance minister in a late-night cabinet reshuffle. 

The country had also entered a recession at the end of 2016. The rand plummeted 4% against the dollar in reaction to Gordhan being replaced.

For Fitch, the reshuffle signalled a coming change to the country’s economic policy. 

“The tensions within the ANC will mean that political energy will be absorbed by efforts to maintain party unity and fend off leadership challenges and to placate rising social pressures for addressing inequality, poverty and weak public service delivery,” the ratings agency said in its downgrade decision. “The treasury’s ability to withstand departmental demands for increased spending may also weaken.”

S&P said ANC infighting would probably hurt growth and fiscal outcomes, especially as efforts to improve Eskom’s financial position are put on the backburner. In the 2017-18 financial year, the budget deficit widened to 4.3% of GDP from 3.4% prior.

Later in 2017, Cyril Ramaphosa was elected president of the ANC. He became the president of the country two months later.

In the years that followed, South Africa’s budget deficit continued to widen, reaching 5.7% in 2019-20 before soaring to a record 14% in 2020-21, and the country fell deeper into junk status.

But towards the end of 2021 and into 2022, the country’s credit outlook started to look up. South Africa’s better prospects were underpinned by much-improved fiscal conditions driven by the commodity boom-induced revenue windfall.

‘Glass half full’

Jones Gondo, the senior credit research analyst at Nedbank, noted that the mining windfall was a catalyst for South Africa’s policy makers to make the corrections necessary to claw back investment grade.

South Africa seems to have maintained this momentum, with Finance Minister Enoch Godongwana delivering a cautiously optimistic medium-term budget policy statement last month. The government now expects the country will return to a primary surplus in 2023 for the first time in more than a decade.

Moody’s was the only ratings agency that released a response to the policy statement.

It was less positive about the sovereign’s ability to reach its fiscal targets, noting the country’s constrained economic growth and the expectation that there will be higher spending pressures on the horizon. 

Moody’s is less bullish than the treasury about the country’s growth, which looks to be a sticking point in any upcoming upgrade decisions.

Hugo Pienaar, the chief economist at the Bureau for Economic Research, noted that South Africa has built up a good track record — reining in public finances and announcing progress on structural reforms — in the past 12 months to signal it is ready for an upgrade.

“However there is uncertainty about how long that can continue. So, if you see it as a glass half full, you would say there is some momentum here. It has actually been coming for some time,” Pienaar said.

“But still, I think next year is going to be difficult for South Africa given the state of the global economy and load-shedding. And even though there has been momentum on reform, I think we will only see that start to come through after 2023.”

South Africa’s growth story is complicated, especially considering the headwinds to the global economy. The treasury expects the country’s economy to grow by an average of 1.6% over the next three years. But significant downside risks to global growth could temper this. 

Then there is the country’s ongoing energy crisis.

The growth dilemma

According to Nedbank’s analysis, electricity constraints shaved 20 basis points off growth in 2022 and the energy crisis will intensify in 2023. According to the bank’s economists, new generation capacity will start to close the gap between energy supply and demand in about 2026.

Pienaar said poor growth leads to a vicious cycle, requiring the state to cough up more social spending to avoid unrest. But he said there is some upside to the treasury’s growth forecast given increased energy investment.

“It is hard to quantify, but we could be surprised about how much the embedded generation reforms unlock in terms of investment over the next three years. And I think there are probably a lot of forecasters who have not put enough in their numbers already.”

Sanisha Packirisamy, an economist at Momentum Investments, said there are a couple of factors that have only recently come to bear to indicate that it is probably too early for South Africa to be upgraded. 

The deterioration of the global economic outlook is one factor. The other is South Africa’s commodity windfall has started to peter out as the country’s terms of trade become less favourable.

The Moody’s growth forecast — between 1% and 1.5% over the next three years — signals that the ratings agency is looking forward to any fast progress being made on South Africa’s structural reforms, Packirisamy noted. 

“And they have said in the past that they will upgrade us if they see significant progress in alleviating those growth constraints … I think we are quite far away from that upgrade scenario.” 

In May, S&P upgraded South Africa’s rating to a positive outlook, which means there is a one in three chance the country will be upgraded, said Packirisamy. 

But, again, the global picture has worsened since the upgrade by S&P, which has said an upgrade will happen if the country’s growth is higher than the ratings agency’s forecast. The chance of this is slim, considering less accommodative global dynamics and the slow pace of structural reforms.

This story has been updated to reflect that Moody’s has not in fact scheduled a credit ratings assessment for South Africa on Friday.