Double Ratings Relief - S&P and Fitch

S&P and Fitch – Double Ratings Relief

South Africa has just dodged two ratings bullets. Last Friday evening S&P (the world’s largest credit rating agency) maintained South Africa’s investment grade credit rating of BBB –ve (with negative outlook) and on Wednesday Fitch maintained its BBB- (stable outlook) rating. Most people had expected (hoped) that SA would not get downgraded to “junk” – RMB had put the probability at 40%. Markets nevertheless heaved a sign of relief and the rand strengthened by around 3% vs. the dollar on the S&P announcement.

Party Time…..?

Optimists love to point out that less than 10% of South African government debt is denominated in foreign currencies and that SA’s foreign currency rating (which is what all the fuss is about) is therefore not that relevant. However, foreigners also own lots of rand denominated debt, which means that about 35% of SA’s government debt is held overseas. An investment grade credit rating is important to maintaining those investors’ confidence in SA, not to mention our own business confidence.

Bizarrely, I will now argue that credit ratings, or rather the ratings agencies (S&P, Moody’s Fitch) are largely irrelevant to the average South African. This is because ratings agencies are a little bit like judges on Idols or X-Factor: people decide whether they like an artist way before the judges get a chance to speak and viewers can decide to vote with or against the judges’ opinions. In reality, yields on 10-year South African government bonds are already around 9.2% (yields are a bit like interest rates – lower is better in this case). This means that they trade in the same range as Turkey (9.35%) and Russia (8.87%), both of which are rated junk (BB+) by S&P. Investors started treating SA’s debt as junk as far back as September of last year. The bottom line is that the economy is what really counts and that the credit rating will take care of itself if the economy is doing well and the country is politically stable.

….Sadly NO

“The outlook remains negative, reflecting the potential adverse consequences of low GDP growth and signaling that we could lower our ratings on South Africa this year or next if policy measures do not turn the economy around.” From S&P’s 3 June Press Release

South Africa’s next big hurdle is S&P’s next update, which is due in December. S&P began its recent press release with two important warnings 1) that low economic growth could weaken government’s social contract with business and labour and 2) that political tensions are putting SA’s investment grade rating at risk. Fitch’s press release had a similar tone, also though they became a little more personal, discussing “the dismissal of two finance ministers in a week”, Nkandla, the corruption case against President Zuma and rising tensions within the ANC. Fitch also went as far as to predict that the ANC will lose some support in the local government elections. Interestingly (and I’m not sure how to feel about this statement) Fitch also said that SA’s political risk “is not out of line with ‘BBB’ peers”.

The three things that could lead S&P to downgrade SA to junk in December are:

1) Low real GDP growth: S&P expects growth to be 0.6% this year (Fitch 0.7%) and 1.5% next year (Fitch also 1.5%). The structural measures that they believe will determine whether this is achieved are: the provision of a reliable source of electricity - hello Eskom; labour market reform – strikes, inflexible labour laws and youth unemployment are crippling the economy; and the mining code – especially the sensitivity around BEE negotiations.

2) Political interference in institutions: S&P specifically mentions the Public Protector and the Judiciary and praises SA for its strong democracy and independent media.

3) An increase in debt due to financially weak government-related entities: Government debt, net of liquid assets, is around 45% of GDP. Government also provides financial guarantees to Eskom, SAA and Sanral. The value of these guarantees takes debt to GDP closer to 55% and the ceiling that S&P provides for an investment grade rating is 60%. This last point will be particularly important to Pravin Gordhan as he tries to reign in SAA.

Fitch concentrates on GDP growth and the budget deficit. They point out that SA’s 5-year average GDP growth is just 2.2%, compared with a ‘BBB’ country median of 3.3% and the budget deficit of 4.3% in 2015 was much higher than the ‘BBB’ median of 1.4%. The key assumption to Fitch’s rating is that the reserve bank remains committed to its 3-6% inflation target.

“Team SA” and Finance Minister Gordhan have really done an excellent job to preserve SA’s investment grade rating. Unfortunately all that marketing will come to nothing if the economy continues to tank. SA’s economy shrank by 1.2% on an annualized basis in the first quarter, much worse than the 0.1% consensus forecast. The real trick will now be to avoid a recession. This means no more political infighting or populist policies ahead of the local government elections in August.

If you would like to end on a positive note, then the good news is that S&P will change its outlook from “negative” to “stable” if it observes policy implementation that leads to “improving business confidence and increasing private sector investment”. More importantly, if government can make these changes, then there should ultimately be higher GDP growth, in which case who cares about S&P!

Dr Andrew Louw CFA

(Sources:, S&P, Fitch)