South Africa’s credit rating fortunes are balanced on a knife-edge.
Johann Els, senior economist at the Old Mutual Investment Group, says there is a 50-50 chance that South Africa’s sovereign credit rating won’t be downgraded to junk status.
This is a somewhat worse probability than a few months ago as political uncertainty has increased “quite a bit” in recent weeks, he says.
“So it is a very close call at the moment.”
His comments come after Finance Minister Pravin Gordhan on Tuesday expressed optimism about South Africa’s chances of retaining its investment grade rating in December.
S&P and Fitch both have South Africa on the lowest investment-grade rating (BBB-), but S&P has a negative outlook while Moody’s rates the country two notches above sub-investment grade (Baa2) with a negative outlook.
Els says a couple of steps have to be taken to avoid a downgrade and it seems the Minister and government are aiming to address these issues.
These include strengthening state-owned enterprises and ensuring that it over delivers on fiscal targets. Slower economic growth and lower tax receipts will make this difficult and National Treasury will have to announce tax hikes and/or spending cuts.
“It will probably end up being a combination of those,” Els says.
There is also an expectation of an announcement around secret strike ballots.
These three areas are probably the minimum requirements to avoid a downgrade by S&P. If government can deliver in these areas the probability of being downgraded can shift quite a bit lower than 50%, Els argues.
Although concerns around a downgrade remain, the economic outlook seems better than it did a few months ago.
Inflation and growth
Els reckons inflation has peaked and that interest rates could be cut during the latter part of next year.
An improved inflation outlook is mainly the result of an improvement in volatility drivers – the rand and oil – which have helped to facilitate petrol price reductions in August and September. With a more “normal” rainfall season expected, the outlook for food inflation has also improved.
Els says even though they expected food inflation to come down rapidly next year, the decline will probably be even more significant than previously anticipated.
The pass through from a weaker rand has also continued to be quite weak and prices haven’t increased to the extent one would have anticipated.
At the same time the economic growth outlook seems to have improved, albeit only slightly. Reserve Bank governor Lesetja Kganyago recently indicated that it would adjust its economic growth expectation for the year from the current 0% at its next meeting.
The Old Mutual Investment Group expects growth of 0.5% this year.
“On average with a negative first quarter [-1.2%] and a positive second quarter number [+3.3%] , growth in the first half of this year was 1.1%. The same growth in the second half will give us that 0.5% growth for this year.”
Although the pick-up expected into next year remains weak, it seems that the economy has turned the corner.
“We don’t expect a recession, but of course [a] recession is academic. Two slightly negative quarters would be a recession but very low… continuously positive [growth] would be as bad or worse than having a short sharp recession.”
Els says while the medium-term budget policy statement (MTBPS) is not normally a forum to announce tax changes, it could be different this year and Treasury may be forced to announce some changes, even if it doesn’t provide detail.
The budget numbers will however have to convince the ratings agencies that it is going to stick to fiscal targets.
“There will also probably need to be expenditure cutbacks. Expenditure seems under control, but we probably need to see further evidence of that.”
The wage bill, social grants and interest payments account for 58% of total government spending, and there isn’t much wiggle room in these areas.
Els says unfortunately the easiest way to reduce expenditure is to cut capital spending, but it would be bad for the economy if the belt is tightened too much in this area. There also seems to be room for the government’s chief procurement office to cut back on inefficiencies – not only corruption – but with regard to government contracts and business.
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