SA credit rating outlook dims

Updates of South Africa’s credit rating are imminent – S&P Global Ratings will issue its review on Friday (19 May), and others are expected to follow soon thereafter.

Unfortunately, the situation looks dire, with all the agencies previously warning that the ongoing electricity crisis would undoubtedly impact economic growth and increase the country’s credit risk.

S&P Global has already downgraded SA, in an unscheduled sovereign debt rating announcement on 8 March – when it changed the outlook from “positive” to “stable”.

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While S&P Global affirmed SA’s foreign currency sovereign credit rating at BB-/B, it said economic growth is facing increasing pressure from infrastructure constraints, “particularly severe electricity shortages”.

It said then that European Union regulations concerning the timing of credit rating updates and deviations from the announced calendar are only allowed in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation.

“In this case, the reason for the deviation is the impact of persistent electricity shortages and infrastructure constraints on economic growth,” said S&P.

“Reforms to address infrastructure shortfalls and to improve governance and performance at state-owned enterprises (SOEs) are slow, weighing on growth, while contingent liabilities from SOEs pose continued downside risks to South Africa’s fiscal and debt position.”

Since then, these problems have worsened. In addition, most economists and financial institutions have revised their economic growth estimates downwards.

A spokesman for S&P Global told Moneyweb the agency cannot provide much information ahead of a formal announcement, but highlighted pertinent facts that provide an indication of where it stands:

• The stable outlook on both the foreign and local currency ratings balances South Africa’s credit strengths – particularly a credible central bank, a flexible exchange rate, an actively traded currency, and deep capital markets – against infrastructure-related pressures on growth and downside risks to the fiscal and debt position.
• Downside scenario: We could lower the ratings if the ongoing implementation of economic and governance reforms does not progress as planned, resulting in further deterioration in economic growth, or higher-than-expected fiscal financing needs. This could, for example, result from a deepening of the electricity crisis or if critical infrastructure constraints worsen.
• Upside scenario: We could raise the ratings if there is an improving track record of effective reforms, resulting in structural improvements in economic growth alongside a reduction in public debt and contingent liabilities.

READ: A third of Vodacom’s network has no power at any given point

“Despite the government’s attempts at reforming the power sector, acute electricity shortages pose downside risk to both short- and medium-term growth prospects. The economy contracted by 1.3% on a quarterly basis in fourth-quarter 2022 as electricity cuts rose sharply over the period,” S&P Global said.

“The downturn was broad-based, with the agricultural and mining sectors seeing the largest declines. Full-year 2022 real GDP growth now stands at 2% and we have also revised down our real GDP growth forecasts for 2023 to 1% from 1.5% previously and expect growth to average 1.7% in 2024 to 2026.

“Downside risks to this forecast remain prominent, since South Africa has been unable to fully capitalise on the global upswing in commodity prices while continued electricity shortages signal a potentially difficult winter ahead,” it said.

S&P Global noted that government has introduced measures to encourage private sector and renewable electricity generation, but warned that it will take time for additional power supply to materially improve electricity availability for the wider economy.

It also has concerns about government’s procurement processes under the state of emergency that was lifted within weeks following severe criticism and perhaps the realisation that legal steps by several organisations would succeed in having it overturned.

“The announcement of a national state of disaster on 9 Feb 2023 and the appointment of minister Kgosientsho Ramokgopa in the newly created Electricity Ministry on 6 March 2023 was intended to fast track measures to tackle the electricity crisis,” said S&P Global.

“However, concerns have been raised around possible mismanagement of allocations under fast-tracked procurement processes and the multiplicity of ministries that Eskom now reports to, including the new Electricity Ministry,” it added.

“The track record of procuring and constructing sufficient new electricity generation to offset breakdowns and maintenance of an ageing coal-fired power fleet has been poor.”

It added that contingent liabilities tied to Eskom and other SOEs are likely to remain a risk to the economy and the government’s fiscal position until there is an adequate track record of improvements in operational and financial performance.

We know there has been no improvement in either operations or financial management. For instance, several large SOEs have not yet published financial results for the financial year to March 2021.

S&P Global added another concern: “On 24 February 2023, the Financial Action Task Force (FATF) included South Africa on its grey list of countries with structural deficiencies in monitoring, preventing and combating money laundering, terrorism financing and illicit financial flows. We believe the grey listing could weigh on government borrowing costs and raise financial transaction and compliance costs for the economy and trade flows.”

Fitch

Fitch Ratings recently affirmed its rating for SA foreign currency debt at BB- with a stable outlook in a note that gave a general overview of SA’s economic prospects.

A spokesman for Fitch responded to questions saying the agency does not publish upcoming review dates for SA or any other countries where the lead analyst is not based in the European Union in accordance to regulations. However, he provided a few reports in which he highlighted comments relating to concerns about the ongoing and worsening load shedding.

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“SA president Cyril Ramaphosa’s declaration of a national state of disaster during his State of the Nation Address [Sona] illustrates the challenges relating to the country’s electricity crisis. There is some headroom at the sovereign’s rating of BB- to absorb a temporary impact on economic metrics from load shedding, but a failure to address the problem over the medium term could add to downward pressure on the rating,” according to one report.

“Problems in the electricity sector, particularly with the state-owned power utility Eskom, were also the focus of last year’s SONA, but the situation has continued to deteriorate.

“The generally poor track record on executing and Eskom’s governance problems, highlighted by the resignation of Eskom’s chief executive in December, suggests further delays are possible,” according to Fitch.

“The power crisis is the most acute aspect of SA’s current economic difficulties.”

The rating agency also noted other problems.

“The country faces other major challenges, including growing problems at the state-owned infrastructure company Transnet that are affecting the ability of mining companies to export bulk commodities,” it says.

Fitch points out that when it confirmed SA’s debt rating at BB- in November 2022, it assumed power shortages would not significantly improve in 2023 and might improve only slightly in 2024.

“SA’s low growth potential remains a key credit weakness. Should infrastructure problems cause a further decline in potential growth, that could eventually weigh on the sovereign rating,” it said.

“The further deterioration of electricity supply goes beyond our base case and presents downside risks to our forecast of December 2022 that economic growth will average 1.1% in 2023.”

It is ominous that the comments highlighting the electricity problems were published at the end of February 2023 and that load shedding has become much worse since.

Moody’s

While Moody’s Investors Service was more positive towards SA in the past, it also warned of problems ahead of the 2023 budget speech.

“The effects [of continued electricity disruptions] on business, consumer sentiment and investment will weaken the country’s already subdued economic growth prospects and threaten social and political stability,” it said.

Its last credit rating report awarded SA a debt rating of Ba2 with a stable outlook on SA’s local and foreign currency long term debt.

This rating, issued in April 2022, was actually a bit of an upgrade when Moody’s improved the outlook from negative to stable.

Moody’s did not respond to queries for comment or advise when its next review is due.

Ray of hope?

Rating agencies note that they focus on the facts and figures and calculate rating according to robust models.

Consumer and business sentiment come into play, but apparently not that much.

The uptick in tax collections and SA’s deep local capital markets were important considerations that maintained ratings over the last few years, albeit that debts are still considered to be junk.

Maybe sitting in the dark or starting the day without coffee is just making everyone more gloomy than we need to be.

This article originally appeared on Moneyweb and was republished with permission. Read the original article here.

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