Fitch: SA outlook stable, but power crisis is affecting growth

Fitch Ratings agency has affirmed South Africa’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) to ‘BB-‘ with a stable outlook.

But, the agency has warned that rising government debt, low trend growth and inequality are complicating fiscal consolidation efforts.

Constrained power supply shortages:

Electricity shortages are having a direct impact on the country’s growth and the current crisis could worsen further before new supply, mostly in the form of independent power producer (IPP) projects, comes on line.

“While the government is making progress with its reform agenda, the scale of measures (beyond electricity) is too limited to make a significant difference to potential growth in the medium term,” said Fitch.

Growth is still supported by post-pandemic normalisation and high prices for South Africa’s key commodities, but these factors will fade gradually as the international environment becomes more challenging, the rating agency warned.

Rising inflation is constraining monetary policy. Inflation rose to 6.5% in May, above the 3%-6% target range, from an average of 4.6% in 2021.

Similar surges are being seen in many other economies, and it has already triggered four rate hikes this cycle

“The credibility of monetary policy remains an important credit strength. The banking system is sound despite operating-environment risks, with an average Viability Rating for the country’s five major banks of ‘bb-‘,” it said.

Public finances better than expected:

Thanks to the country’s high-performing mining sector which Fitch says enjoyed ‘buoyant profits’ and growth of fiscal revenue, including VAT, public finances are looking better than expected.

“Revenue has continued to outperform at the end of the fiscal year ending, March 2022 (FY21/22), and we now estimate a consolidated fiscal deficit of 5.3% of GDP for that year, down from 10% in FY20/21 and much lower than the government estimate in November of 7.8%.”

Fitch expects the consolidated government deficit to stabilise at around 5.5% of GDP over FY22/23 to FY24/25.

The ratings agency predicts that revenue will again exceed government forecasts in FY22/23 before slowing significantly, as revenue is now historically high and the boost from commodity prices will fade.

But, it says that the government’s consolidation strategy relies heavily on wage restraint that depends on wage negotiations.

“We expect a modest overshoot of salary spending in FY22/23 and wage increases in line with inflation in subsequent years.”

Social spending pressures:

The government has approved a one-year extension of the special relief of distress grant, at a cost of R44 billion.

Large unallocated reserves for subsequent years may create some room for further continued social spending, but Fitch is expecting a permanent new social spending will be approved that will exceed these provisions.

“This and higher compensation would only be partially offset by savings elsewhere. Initially, this could be compensated by high current revenue, but could imply a further weakening of expenditure ceilings as a fiscal anchor.”

Government debt still rising:

We expect general government debt (gross loan debt plus local government debt of 1.3% of GDP) to rise to 75.9% in FY24/25 from 68.7% in FY21/22 (significantly below our forecast of 71.9% in December).

The FY24/25 forecast is broadly in line with the government’s projections for the gross loan debt, but debt is expected to stabilise in FY24/25 and then gradually decline, while we expect debt to continue rising beyond this.

Substantial Contingent Liabilities

Fitch warns that the poor finances of many public enterprises pose considerable risks to the public purse.

Eskom is expected to require an additional R150 billion, which is not factored into the debt forecast due to the uncertain timing and form of support.

External accounts boosted by commodity prices

High prices for South Africa’s key export commodities boosted the current account to a surplus of 3.7% of GDP in 2021.

The surge in fuel prices will lead to a smaller surplus of 1.7% this year, before a gradual decline in export commodity prices and higher imports turn the current account to a deficit of 0.9% in 2024.

However, together with the flexible exchange rate regime, this will remain sufficiently strong to help contain the impact of potential external shocks as global monetary tightening creates a more volatile environment.

“Government foreign-currency debt is low, but the high participation of non-residents in the local-currency government debt market (28.1% in May) is an external risk factor,” said Fitch.

Socio-political context adds to risks

Exceptionally high unemployment (34.5% in 1Q22) and income inequality added to pressures on public finances and contribute to broader political risks, illustrated by violent unrest in July last year.

The weakening of the ANC in local elections last year points to shifts in the political system, although more radical shifts affecting economic policy-making remain only a tail risk.

The reports on state capture during the administration of former president Jacob Zuma have highlighted the vulnerability to corruption of the political system, although the government has made significant progress in addressing this.

South Africa has an ESG Relevance Score (RS) of ‘5’ for political stability and ‘5[+]’ for rights and for the rule of law, institutional and regulatory quality and control of corruption.

These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM).

South Africa has a medium WBGI ranking at 57. Below median scores for political stability are offset by strong and effective institutions, including the judiciary, the National Treasury and the central bank.

Factors that could, individually or collectively, lead to negative rating action/downgrade include:

• Public finances: Further significant increase in government debt/GDP, for example, due to a failure to narrow the fiscal deficit
• Macroeconomic performance, policies and prospects: A further weakening of trend growth or a sustained shock that further undermines fiscal consolidation efforts and raises socioeconomic pressures in the face of exceptional inequality

Factors that could, individually or collectively, lead to positive rating action/upgrade:

• Public finances: Progress on fiscal consolidation that increases confidence that government debt/GDP will stabilise over the medium term

• Macroeconomic performance, policies and prospects: Greater confidence in stronger growth prospects, sufficient to support fiscal consolidation and address challenges from high inequality and unemployment

National Treasury ‘noted’ Fitch’s decision saying it would continue to demonstrate its commitment to fiscal sustainability and enable long-term growth by narrowing the budget deficit and sizable debt.

“South Africa’s steadfast commitment to restoring the sustainability of public finances is supported by better-than-expected revenue collection in the current fiscal year,” said Treasury in a statement.

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