South Africa may be hours from a junk rating that will last years

South Africa might be just hours away from losing its investment-grade at S&P Global Ratings - a relegation that could take years to undo.

With a credit assessment due on Friday, the country’s foreign-currency debt is at risk of being rated junk by S&P for the first time in more than 16 years.

Only six of 20 countries reduced below investment grade by S&P over the past three decades have regained it, and that took from 13 months to more than 11 years, data compiled by Bloomberg show.

Seven of 12 economists surveyed by Bloomberg last month said the nation’s foreign-currency rating will be downgraded to junk on Friday, while three foresee it happening in June.

Political turmoil in Africa’s most-industrialised economy, including now-dropped fraud charges against Finance Minister Pravin Gordhan, has overshadowed efforts to boost investor and business confidence.

The slowest gross domestic product growth this year since a 2009 recession will complicate Gordhan’s pledge to narrow the budget deficit and to limit government debt, while promised structural reforms have been hampered by infighting in the ruling ANC and government departments.

“If SA does get a downgrade, I think we are looking at at least three to five years before it could possibly get upgraded again,” Per Hammarlund, chief emerging-market strategist at SEB SA in Stockholm, said by phone. “Given the way politics are moving now, it seems as if the political paralysis will continue and that doesn’t bode well for economic reforms.”

Negative outlook
Fitch Ratings on November 25 changed the outlook on its BBB- rating, which is one level above junk, to negative from stable and warned that continued political instability could result in a downgrade.
Later the same day, Moody’s Investors Service, which rates SA's debt at the second-lowest investment grade level, with a negative outlook, said in a credit opinion political infighting that generates policy uncertainty and impedes structural reforms could lead to a cut.
While a reduction to junk on the foreign-currency rating may hurt sentiment and add to woes for the rand in a year of emerging-market uncertainty - fuelled by Brexit and the election of Donald Trump as US president - it won’t necessarily lead to significant forced bond selling by foreign investors.
SA's local-currency ratings, which are usually referenced for inclusion in global benchmark indexes such as Citigroup’s world government bond index, are still above junk, even after Fitch cut its assessment to the lowest investment-grade level in July.

 

“We think S&P will look to downgrade the country’s local-currency rating on Friday from the current BBB+,” Jeffrey Schultz, a senior economist at BNP Paribas Securities in Johannesburg, said an e-mailed note. “Such a move, we believe, would serve as a warning signal that S&P is uncomfortable with the direction in which South Africa’s debt-to-GDP ratio is moving and that should structural economic reforms not materialize to boost growth before June next year, a foreign-currency downgrade is inevitable.”

 

Higher risk

A cut by S&P would move the company’s rating of the nation’s foreign-currency debt to the same level as Russia and Portugal. Investors already consider SA more risky than Russia, with the cost of insuring against non-payment of debt for five years using credit-default swaps 15 basis points higher than for that country. The rand strengthened 0.3% to R14.07 to the dollar by 8.15am in Johannesburg. 

Gordhan has led efforts to stave off a downgrade while wrangling with President Jacob Zuma over the management of state-owned companies and the national tax agency. A failed bid at the ANC’s national executive committee meeting this week to oust Zuma increased speculation he will be replaced as the nation’s president.

The economy will probably expand 0.4% this year, according to the Reserve Bank. That will make it difficult for Gordhan’s to meet his target to narrow the budget deficit to 2.5% of gross GDP by 2020, from a projected 3.4% this year, and to rein in gross government debt that’s forecast to peak at 53% of GDP in the year through March 2019.

“The past has shown that regaining an investment-grade rating isn’t easy,” George Herman, head of South Africa investments at Citadel Investment Services in Cape Town, said. “We need some structural changes in the economy to improve growth, but those are going to take tough political decisions.”

Bloomberg/ by Arabile Gumede