Can South Africa avoid a downgrade in December?

RYK VAN NIEKERK: Several rating agencies are looking carefully at the South African economic and political landscape as part of their re-evaluation of South Africa’s credit rating, and one of the most important rating agencies is Standard & Poor’s. On the line is Gardner Rusike. He’s Associate Director of Sovereign Ratings and International Public Finance at Standard & Poor’s.

So Gardner, welcome to the show. We are living in very interesting times, both politically and economic. How closely to you monitor the short term political developments?

GARDNER RUSIKE: Thank you, so we look at a number of factors of which the two you have mentioned, politics and economics and these are very important. They are fundamental. We do believe that changes in these factors can impact on the credit worthiness of a sovereign. So in the case of South Africa, the ratings have been under pressure because of the economic performance, the growth has been weak. The wealth levels have been declining for a while and these have put pressure on the ratings.

But more importantly is that the political dynamics, particularly in the last nine months or so, they’ve increased significantly particularly on the negative side. There’ve been a number of developments, negative political developments which we believe if they are not kept in check, they could impact on the government’s programme, they could impact on the economic reform momentum and can impact as well on the growth objectives which the government would ultimately like to achieve, which ultimately impacts on the ratings.

RYK VAN NIEKERK: Let’s talk about the political situation at the moment. South Africa definitely has some political turmoil and uncertainty. How does that compare with other developing nations that are also on the cusp of being downgraded? Are we out of line? Is it worse than you would have liked to see to protect an investment grade rating?

GARDNER RUSIKE: Yes, so we do believe that the political environment or politics in particular do impact on the policies that the government adopts and also does impact on the outcomes of the policy that the government has taken, and so we monitor it quite closely. Also we had the number of events particularly in the last 12 to 18 months, but we’re also on the verge of moving the investment grade and some of these do include Brazil and Russia and these also lost their investment grade status some time last year, but I think the issues are different for each country. For Brazil it was a combination of the economic issues as well as the fiscal issues. and then for Russia as well, it was the oil price issues as well as the economic and the sanctions that Russia also got.

So it is important to say that we accept the country when it’s own credit matrix and where we see that there are risks reflected and I think for South Africa reflect with a negative outlook and we’ve had a negative outlook I think since December and for the other peers that I’ve mentioned as well, they probably had a much shorter time or negative outlook before the ratings went down. But it’s not always the case that ratings will always go down when there’s a negative outlook. There are chances that the ratings can be revised back to stable which especially if some of the contents and components that go into a credit rating are addressed.

RYK VAN NIEKERK: One of the big political topics at the moment is the potential arrest of the Finance Minister, Pravin Gordhan, who has engaged the rating agencies, together with business and labour to try and protect our investment grade. It’s a very popular statement to make that if the Minister is arrested we would lose our investment grade. Would that be the case?

GARDNER RUSIKE: Not necessarily. So we don’t tie individuals to a rating decision. Right? The Minister of Finance represents the Treasury and the policy stance that the Treasury takes. So it’s important to put that into context. But in South Africa’s case, it also does bring a few questions in a way, if you think about it that there was a change in December and there will be a change, if there is another change. So it’s important for us to understand the intention, the rationale for the change and the implications of what it does to the Treasury fiscal stance.

And then secondly as far as the economic but its full momentum is concerned, I think there is a social contract between business labour and government and if there are changes to individuals as well, what it does to that social contract and what it does to investor confidence. But importantly, it’s not about tying rating decisions to individuals but policy stances that are taken by government.

RYK VAN NIEKERK: Let’s talk about economic growth. When the rating agencies, I think, all three major ones announced their credit ratings at the beginning of the year, it was before we saw the economic growth figures for the first and second quarters. Now in the first quarter we saw a shock number of -1.2% and then we were all surprised about the 3.3% growth in the second quarter. Did you expect those numbers?

GARDNER RUSIKE: I think broadly the second quarter was above consensus and it was a positive number and it’s always good to get positive numbers, but I think if you put it in the context as you have mentioned that we have some fluctuations between Q1 and Q2, but overall we are still looking at the projection for 2016, that we put out in June which is up 0.6% which is still on the high side, given the performance so far in the first half of the year.

So I think it’s important to put it in the context of the full year projection as well as the expectations that we have for the medium term. But it’s for growth next year and the years to come and it’s important as well that these are positive numbers, if they are more structural whether than cyclical which also is probably the case now with some of the Q2 numbers. So it’s important that structural measures are in place which can support structural improvement in growth and you can have higher GDP growth levels for medium term.

RYK VAN NIEKERK: You are scheduled to announce an updated rating for South Africa around December. We are close to the end of the third quarter and we will not see another economic growth number for the third quarter before you will announce that new rating or hopefully unchanged rating. Would your whole decision then be based on what you saw in the first and the second quarters?

GARDNER RUSIKE: Well, it also includes high frequency data in as much as the Q3 number may not be published, but you’ll have some high frequency data that can give some sort of indication of where Q3 performance will be, but I think more importantly for us is we mentioned in the June report is that government has identified a number of key structural measures and they are looking at this so it’s important for us to see at least some progress on these structural measures that involve issues around the mining sector, issues around labour reforms among many others. So implementation of some of the things can provide a higher growth path which can help to inform our rating decisions.

RYK VAN NIEKERK: Can you explain exactly what is the process you follow to take a decision on a rating for South Africa?

GARDNER RUSIKE: The process is we have analytical teams which engage with the individual sovereigns. They meet with the government and different players and from the meetings we form our own opinions, we write our reports and we discuss them at our credit committees. We come to a decision and we communicate that decision to the relevant authorities and a decision will be published after some time. So the schedule is to publish on 2 December for the next rating decision as far as we are concerned at the moment.

RYK VAN NIEKERK: How often do you engage government?

GARDNER RUSIKE: We have six monthly, we publish every six months, so we have two publications each year and we always engage with government continually as well as around a publication as well.

RYK VAN NIEKERK: So when was the last engagement with Treasury?

GARDNER RUSIKE: We engaged – we are always engaging with Treasury, so even after the June publication, we’ve engaged with them and we continue to engage. But formerly we did engage before the June publication.

RYK VAN NIEKERK: Your friend quoted as saying, that obviously you have these scheduled meetings where you discuss and form opinions about the rating, but that you can call out of schedule meeting to re-evaluate the rating between the scheduled meetings. Have you had a special meeting between the meetings or since the one you’ve had in June?

GARDNER RUSIKE: If we did have you’d have seen a publication. So if there’s no publication we can assume there’s no such discussion.

RYK VAN NIEKERK: What can South Africa do in these last few months to try and avoid a ratings downgrade from Standard & Poor’s?

GARDNER RUSIKE: I mean it’s not so much about what can be done by the individual parties but it’s also not so much about the ratings but about the components that speak to a rating. So some of the factors that we’ve highlighted that are weaknesses and we believe that addressing some of these factors can help stabilize the ratings and these factors include economic quickness and these factors include political risks. So it is important to stabilize these factors and to improve on investor confidence which would help to improve on investment which would ultimately help to improve on the higher economic growth.

RYK VAN NIEKERK: Other developing markets also being downgraded? I don’t think I’ve seen an upgrade recently of a developing market. Is there a negative view on many other markets apart from South Africa on your side?

GARDNER RUSIKE: Well I think Sovereign Ratings more generally in this region have been under pressure for a number of reasons. One is because the global environment is weak, commodity prices are still weak. So for a number of countries that depend on commodity revenues and export revenues, they have suffered with lower influence. So ratings have been under pressure and I think without the sufficient data, ratings do get under pressure. So that’s the kind of environment we are dealing with at this moment. Credit worthiness is lower but the tides always change so it is the tide that we are in at the moment for this region.

RYK VAN NIEKERK: It is the South African foreign denominated debt that is on the verge of an investment downgrade from yourselves. Do you look at all at the bond rates currently in South Africa which are actually quite high? Some of the Eskom bond rates are in excess of 13%. Do you take that into account that a lot of the risk has already been priced in local debt yields?

GARDNER RUSIKE: No, not necessarily. So we look at it from the fundamental credit factors which are more of your macro-factors rather than the daily performances in terms of the yield, but more of the market pricing and expressing their views. So ours is an analysis on the credit opinion based on the fundamental factors that we see in a country rather than the actual yield.

RYK VAN NIEKERK: Just lastly, if you do downgrade a sovereign, a country like South Africa, what is the average time for a country to regain an investment grade rating?

GARDNER RUSIKE: Yeah, I mean broadly it differs depending with what a country does. So on average you’re talking between seven to eight years, but some countries have come back within a period of two years and some have come back over a period of up to 10 years or more than that. So it’s more about addressing the components of a rating where weaknesses have been raised that have led to a downgrade and if those are addressed much quicker, then you can get a rating coming back into the investment grade.

So that has happened in South Korea, that has happened in Europe and probably more Latin American countries are the ones that have taken longer to come back and maybe some have actually not come back. So it’s important to understand the components and addressing them, all of them. If these components are not addressed adequately, it can even lead to further downgrades along the non-investment grade ratings categories.

RYK VAN NIEKERK: Thank you Gardner. That was Gardner Rusike, he is the Associate Director of Sovereign Ratings and International Finance at Standard & Poor’s.

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