Possibility of credit rating downgrade looms

This week sees global rating agency Standard & Poor’s (S&P) deliver its country review on SA with many wondering whether it will downgrade the country’s credit rating.

Investec economist Annabel Bishop says she remains with her baseline forecast that the agency downgrades SA’s long-term sovereign local-currency debt rating by one notch‚ to BBB (from BBB+ currently) to bring greater alignment between the hard and local currency ratings.

This would still be an investment grade rating‚ she points out.

“Our baseline still expects SA’s long-term sovereign hard-currency debt rating to be left unchanged in June at BBB- (investment grade)‚ with a negative outlook. This hawkish bent of the credit rating agency on SA’s perceived credit worthiness implies that the future rating action is still likely to be a downgrade‚ not an upgrade or stabilisation‚” Bishop says.

She notes that S&P highlights SA’s slowing growth‚ citing it “challenging the ratings outlook” for SA‚ as well as its fiscal and debt burden (as fiscal consolidation is slow).

“The agency noted wealth levels are declining on a GDP per capita basis below most of its peers (in US$ terms)‚ and underperforming the 1-4% band for real GDP per capita growth.

“In particular‚ S&P said in April that ‘(a) range of adverse global and domestic factors continue to weaken South Africa's macroeconomic outlook’‚ with ‘growth ... also constrained by ongoing structural issues‚ such as poor labor market outcomes and infrastructure bottlenecks’.”

Bishop adds that S&P is concerned about the rise in SA’s sovereign debt‚ noting that “fiscal forecasts suggest stabilisation might be near” but perceiving significant risks‚ particularly “(l)ow GDP growth may impact on tax revenue collections”‚ “(r)ising exposures to state owned entities with weak balance sheets” and “(r)ising debt servicing costs as domestic interest rates increase”.

“Unless South Africa enters the down case‚ we do not expect a sub-investment grade rating delivered this year from any of the agencies‚” concludes Bishop.

“Countries without investment grade ratings have higher borrowing costs. A sub-investment grade rating would complicate SA’s fiscal consolidation. Evidence shows it takes several years to regain a lost investment grade rating‚” she says.

She adds that SA could see its local currency rating revised lower to BBB- next year – “from our expectation that it will already drop to BBB this year” - if the country’s economic growth looks to remain very weak and fiscal consolidation to slow. The vast majority of SA’s government bonds are local currency‚ i.e. rand denominated debt.

“ From a hard currency rating (benchmark) perspective‚ SA is at risk of falling into the sub-investment grade category‚ potentially as early as the country review on 2nd December 2016 (not the base case)‚ if fiscal consolidation in South Africa is seen as unlikely to proceed as outlined in the 2016 Budget‚ and economic growth not expected to pick-up significantly‚” says Bishop.

Fitch is also expected to release its review on SA some time soon – possibly around June 8.