November 2, 2019
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STANLIB: Moody’s revises SA’s credit rating outlook after shock deterioration in fiscal metrics
On 1 November 2019, Moody’s Investors Service decided to keep South Africa’s international long-term credit rating unchanged at Baa3, BUT revised the outlook from stable to negative.
This was largely expected by the market following the release of the government’s Medium-Term Budget Policy Statement (MTBPS) on Wednesday 30 October, says STANLIB Chief Economist, Kevin Lings. However, in the months leading-up to the MTBPS many analysts had assumed that Moody’s would keep SA’s credit rating as well as the outlook unchanged at the end of 2019.
The shock deterioration in SA’s fiscal parameters presented by the Minister of Finance in the October 2019 MTBPS, together with the lack of detail in the MTBPS explaining how government intends to remedy the fiscal deterioration, clearly forced Moody’s to change its outlook for SA’s credit rating. The weak economic environment, a further revenue shortfall and additional funding requirements by SOEs meant National Treasury was always going to have to report further fiscal slippage. However, the extent of deterioration announced by Minister Mboweni on 30 October exceeded all expectations, says Lings.
In the two days following the MTBPS the rand/dollar exchange rate has declined by just over 3% and the 10-year government bond yield has weakened by 50 basis points. The negative rating outlook will, unfortunately, increase market uncertainty suggesting that periods of strength in the rand and bond market will tend to lack conviction until the rating position from Moody’s is resolved.
SA has been on a Baa3 rating by Moody’s (with a stable outlook) since 23 March 2018, although as recently as September 2012 SA was an A-rated (A3) country. Later that year SA was cut to a Baa1 rating. When Moody’s first rated SA in 1994, it assigned the country a Baa3 rating, which is equivalent to the country’s current rating. This means that a revision down by Moody’s in 2020 would suggest that it now views SA as a greater financial risk than in 1994. Sad.
Moody’s has revised down its medium-term growth projections for SA to a range of 1% to 1.5% over the next three years, barely in line with population growth, from earlier expectations of a gradual growth pick-up between 2.5% to 3%. At the same time, it argues that with the inclusion of the Eskom debt guarantees, government’s total debt will approach 80% of GDP at the end of fiscal 2022 and remain on a rising trajectory.
Moody’s states that “the decision to change the outlook to negative from stable reflects the material risk that the government will not succeed in arresting the deterioration of its finances through a revival in economic growth and fiscal consolidation measures”.
In making the decision to revise South Africa’s credit rating outlook from stable to negative, Moody’s made the following four highly critical comments about the government’s fiscal position:
- The government has promoted a number of initiatives in response to the weakening growth and fiscal dynamics. However, “its ability to implement those initiatives in a way which generates broadly-based sustainable growth 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”.
- 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”.
- SA is one of the few countries globally where the average interest rate on government debt noticeably exceeds nominal GDP growth. Given that condition, the government debt-to-GDP ratio will continue rising unless it is able to generate large primary surpluses. The likelihood that it is able to do so has fallen materially.
- This week’s MTBPS does not yet represent a developed, credible fiscal strategy
As far as Moody’s is concerned, the current Baa3 credit rating rests on the “government’s ability to quickly develop a credible strategy to halt and ultimately reverse the rise in debt”. In that regard the 2020 budget in particular will be a key indication of whether or not the government is committed to the fiscal consolidation recommended by the MTBPS. Achieving this in the current time-frame appears highly unlikely.
Overall, the tone of Moody’s credit assessment of South Africa’s is extremely harsh (for good reason) and significantly different from recent reviews. Risks that Moody’s defended just a few months ago have now become points of significant criticism, given the sharp deterioration in the MTBPS. It also appears that Moody’s is placing a lot of emphasis on the National Budget in February 2020 to see if government is able to articulate a much clearer fiscal strategy that can be implemented.
Victor Mphaphuli, STANLIB’s Head of Fixed Income team, says that after the MTBPS, bond markets and the rand reacted sharply because it was evident that SA ran the risk of a full downgrade from Moody’s. Over the next few months, unless government either implements growth-orientated policies or takes hard decisions to bring down the debt to GDP ratio, it is likely that there will be a full downgrade.
The bond and currency markets have largely priced in this risk, meaning the markets are trading at levels as if SA were a fully-downgraded country. If a full Moody’s downgrade is announced after the February Budget, SA will be removed from the World Government Bond Index, forcing investors to sell their holdings. This additional supply of bonds in the local market will negatively affect the bond yields.
In general over the next few months, unless National Budget statement in February 2020 shows a marked improvement, the market will continue to price in a premium. This calls for caution in managing fixed income portfolios.