Supplementary Budget 2020

Moody's changes outlook to negative - but SA's still not junk

On Friday night, Moody downgraded the outlook for its credit rating of the South African government from “stable” to “negative”.

This is the final step before it strips South Africa of its “investment grade” Baa3 long-term foreign-currency and local-currency issuer rating, which will leave it at “junk”.

"The negative outlook signals in part Moody's rising concern that the government will not find the political capital to implement the range of measures it intends, and that its plans will be largely ineffective in lifting growth," the agency said in a statement.

While government has some plans to address problems like unemployment and low growth, it has faced obstacles "in part from outstanding vested interests, in part from the social and political challenge of imposing measures that are initially likely to be detrimental for parts of the population", Moody's said. It gave the example of the new mining charter, which is unlikely to boost investment in the sector given persisting regulatory uncertainty amid ongoing appeals against some provisions of the charter. 

"While high unemployment, income inequality and the social and political challenges they imply for policymakers are long-standing features in South Africa, the obstacles that they pose to the government's plans to raise potential growth and contain fiscal deficits are proving more severe than expected a year ago," Moody's added.

"Acute financial stress for state-owned enterprises, in particular Eskom, continues to require sizeable ongoing support from the government. The development of a credible fiscal strategy to contain the rise in debt, including in the 2020 budget process and statement, will be crucial to sustain the rating at its current level."

The Moody's announcement follows the medium-term budget policy statement, which was tabled this week by finance minister Tito Mboweni and painted an extremely grim picture of government finances.

Government’s debt-to-GDP ratio, which as recently as two years ago was at 50.6%, is currently 61% and will grow to above 71% of GDP by 2022. Government is forking out billions of rands in bailouts for a bleeding Eskom and other state-owned entities, while tax revenue this year will be more than R50bn lower than expected as business and households struggle in a weak economy.

"The current rating rests on the government's ability to quickly develop a credible strategy to halt and ultimately reverse the rise in debt. Such a strategy has not been forthcoming to date," Moody's warned on Friday night.

But Moody's added that the Baa3 rating affirmation takes into account the "country's deep, stable financial sector and robust macroeconomic policy framework".

"The South African Reserve Bank has a demonstrated track record in implementing credible and effective monetary policy and preserving financial stability. Moreover, the government remains committed to fighting the so-called 'state capture', even though the process will take time to gain legitimacy and show results in improved institutions and business environment," it said.

Still, it warned that next year's Budget, in February, will be key in determining whether SA should be downgraded to "junk". 

As expected

Most economists were expecting Moody’s to only downgrade its outlook, but it will still come as some relief, especially to finance minister Tito Mboweni, who warned parliament that the prospects of avoiding a downgrade were “not looking good”. 

If Moody’s cuts South Africa to “junk” it will be a massive blow to the country’s finances. Because SA bonds will be viewed as more risky, investors will demand higher interest rates, which will push up the cost of government debt at a time SA can ill afford larger repayments.

Overseas investors will also be forced to sell an estimated R200bn in SA government bonds. This is because many investment funds are not allowed to invest in “junk” bonds. SA bonds are still viewed as investment grade, thanks to the Moody’s rating – even though two other credit rating agencies, Fitch and S&P, downgraded South Africa to “junk” in 2017.

If Moody’s also downgrades SA to junk, SA bonds will be kicked out of Citigroup’s World Government Bond Index, which doesn’t allow bonds that are junk. Many overseas investment funds track the index and will be forced to sell their holdings.

Mass selling of South African bonds, which are denominated in rand, will put pressure on the rand.

A weaker rand will mean higher fuel prices (SA imports most of its oil) as well as more expensive imported electronics and machinery. Also, South Africa’s maize and wheat prices are linked to the global dollar prices.

But some analysts believe that a junk rating is already priced into the rand value.

The rand was last trading at R15.01/$.

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