It is well known that South Africa’s economy has not gone too well in recent years. Political instability, socio-economic issues and slow economic growth meant that a downgrading was long overdue.
Even though predictions for this year’s GDP were slightly up at 1 %, due to a moderate rebound in commodity prices and a comeback in agricultural production (corn production is expected to be the highest since 1981), the country could face further downgrading by rating agencies. South African ministers met with S&P Global Ratings officials on May 22nd as they wanted to avoid another downgrade.
S&P and Fitch affirmed the recent ratings in another announcement at the beginning of June:
- Foreign currency: BB+/B (S&P), BB+ (Fitch)
- Local currency: BBB-/A-3 (S&P), BB+ (Fitch)
Meanwhile Moody’s has been reviewing South Africa for a possible downgrade since April and will make an announcement this Friday.
Increased political risk will remain elevated this year due to controversy surrounding President Jacob Zuma and the ANC. A cabinet reshuffle in which 10 of 35 ministers were fired is the main cause of downgrades from Moody’s, S&P and Fitch.
Zuma replaced Finance Minister, Pravin Gordhan, who was considered a bulwark against government corruption. The new ministers, are largely unknown to investors which could create further uncertainty in South Africa’s financial markets. The reshuffle was done without the ANC’s approval.
Therefore, internal government and party divisions could delay fiscal and structural reforms. There is an increased likelihood that economic growth and fiscal outcomes could suffer. Political uncertainty is a consequence of the low growth of social stability and worsening industrial relations, especially in the mining sector.
South Africa’s medium-term growth prospects are poor due to structural weaknesses, including continuing energy shortages, rising interest rates, further capital outflows and less supportive capital market environment.
In addition, low consumer and business confidence has put further pressure on growth of economic activity, however, there is a noticeable, slight upward trend. Slow progress in delivering economic and social services in townships and rural areas means the government is behind expectations with its key policies.
Real GDP growth declined each year from 2013 until 2016, from 2.48% in 2013 to 0.28% in 2016. Real economic growth turned negative in Q4 2016 but bounced back in Q1 2017 to 0.9%. The country recovered from the worst drought on record and reported a trade surplus in February and March.
The main contributor to the economy’s slowdown in 2016 was an 11.5% drop in the mining’s sector production.
Unemployment has risen from 2013 until 2016, from 24.73% up to 27.1% in Q4 2016, and even further to 27.7% in Q1 2017. An increased debt-to-GDP ratio of 47.1% in 2014 to 52% in 2016 is one indicator of the low-growth environment.
Following the negative economic environment, South Africa’s credit rating has recently been downgraded to junk status by all major rating agencies. Standard & Poor’s and Fitch rate SA now with BB+ whereas Moody’s downgraded the debt rating to Baa2 from Baa1.
South African 10-year bond yields have been falling since the beginning of the year, however this caused the bond yields to a new high in 2017 and a further weakening of the rand. Since that high at 9.22% on April 10th the 10-year bond yield fell to 8.43%.
A weak rand was pushing up inflation which increases pressure on SA’s Reserve Bank. However, relief following two credit ratings brings the Rand close at a level which would be strongest since March 24th. Inflation in 2016 was at 6.3 %, and above the central bank’s target of 3-6%.
The Short Term Outlook
Fiscal policy is now under pressure from the recent ratings downgrades. Continued increase in government debt, higher borrowing rates, low growth and high inflation provide a weak economic environment which has led to further capital outflow in the past weeks.
A weaker rand also means higher import prices for consumers, even though it might further boost tourism in South Africa. Under the given conditions it seems like that the economy is not likely to increase the pace of recovery and it is unlikely to prevent a further increase in unemployment.
The strong institutional framework built on accountability and transparency which the South African treasury claims as one of its strengths, can in fact only be seen when looking at the central bank and exactly this puts pressure on president Zuma.
South African exports account for about 30% of its GDP and as China’s growth is slowing down, so are exports. This is due to an appreciation of the USD and a devaluation of the RMB, so both the currencies highly affect South African trade and should be looked at closely.
In addition, South Africa will need to refinance about $18bn worth of maturing bonds this year – about 12% of its total issuance, according to Reuters data. This could prove costly for South Africa and could further increase bond yields.
The MPC decided in January to keep the interest rate unchanged at 7%. The inflation outlook would have improved (due to a further appreciation of the rand) according to the MPC meeting from March 30th. This outlook might be in need of adjustment due to recent credit rating downgrades leading to a stop in the appreciation of the rand.
As anticipated in their last meeting, political uncertainty has weakened the outlook for the rand. Overall, as indicated in last S&P report, the SARB has a track record in achieving price stability, flexibility in its monetary policy remains and is considered as independently operating.
South Africa’s most important stock index, the FTSE/JSE (JALSH) remained flat at about 52,870 (as of June 5th) index points. Due to a deterioration in sovereign creditworthiness, risks to the banking sector increase.
This is likely to negatively affect bank’s financial metrics, and therefore knock-on effects on profitability and capital. S&P has already downgraded the banks Nedbank, Absa, Investec and FirstRand to non-investment grade BB+ on 6th of April to fall in line with the country’s credit rating.
Johannesburg’s Banks Index had subsequently lost 10%, but came back and is now around only 3.3% lower since March 27th.
- S&P: BB + (April 2017) and negative Outlook
- Moody’s: Baa2 (April 2017); under review
- Fitch: BB+ (April 2017) and stable outlook
The country could now drop out of some widely used global bond indices, which rely on investment grades and consequently $15bn of investment funds are at risk of flowing out of South Africa. If South Africa cannot maintain the remaining investment-grade rating of local-currency debt, then rand-denominated bonds will be excluded of those indices. Subsequent capital outflows and increasing borrowing costs would add further pressure on the rand.
Investors are now waiting for Moody’s announcement on June 9th and are expecting a downgrade. South Africa’s Central Bank has limited room for stimulus through macroeconomic policies and policy rates are expected to remain on hold since headline inflation is expected to return to 5.9% in 2017 which is below the 6% target. Thus, the priority to stimulate economic growth and job creation can only be achieved through fiscal stimulus.
The current economic prospects for South Africa are poor. The pace of economic growth remains weak, at a rate lower than population growth, within the next 2 years and ongoing political uncertainties will be main issues investors will face when making investment decisions in South Africa.
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