Will Moody’s junk SA?

In early April, Moody’s announced that it would push back its decision on South Africa’s credit rating following the cabinet reshuffle that saw Pravin Gordhan replaced as finance minister. It said it would take an extra 30 to 90 days to make an assessment of the country’s prospects.

Moody’s currently has South Africa’s rating at Baa2, which is two notches above sub-investment grade. This is the highest rating the country enjoys with any of the three major agencies.

Last week representatives from Moody’s visited South Africa and held talks with National Treasury, business and labour leaders. Following these interactions, the agency is expected to announce its decision in the coming weeks.

Speaking at the Old Mutual Investment Managers Conference in Cape Town on Tuesday, the senior economist at Old Mutual’s MacroSolutions boutique, Johann Els, said that he expects Moody’s to lower South Africa’s rating by one notch. This will mean that it will remain investment grade, but he believes that Moody’s will keep the outlook as negative.

“I don’t think there is a decent chance of a stable outlook because growth is still weak and that is a risk for the budget,” Els said.

This is important because the risk of further ratings downgrades will remain.

“If Moody’s and S&P both take the local currency rating into non-investment grade it could potentially mean big outflows,” said Els. “Foreigners own around R600 billion or 31% of rand-denominated government bonds.”

It’s not known exactly how much of this would be subjected to forced selling if South Africa’s debt was downgraded and the country fell out of the major global bond indices, but JP Morgan and Citibank have estimated that it could be between R85 billion and R125 billion.

Els said that it is clear that Moody’s is more worried about the country than it was before the March cabinet reshuffle. However, there were two clear reasons for optimism.

“It’s a huge positive that the nuclear deal is off the table,” Els said. “The ratings agencies look forward three to five years, and in terms of spending in the budget, the nuclear deal is not going to happen in that time frame because the public participation and legal processes now have to be re-started.”

Moody’s is therefore very positive about this, as it is not a financing risk in the short term.

There was also a sense that the new finance minister had given a good impression when he met with the ratings agency.

“This is only a soft measure, but it’s clear that he has people skills, and a willingness to do the right thing,” said Els. “He’s also young and realises that he won’t be serving under this president for very long. He has his own personal ambitions.”

Overall, Els said that Moody’s is aware that South Africa remains an an attractive investment destination due to the broad institutional strength in the country.

“This plays a big role in the future of this country over the medium term,” said Els. “The courts have halted the nuclear programme, and they have forced President Zuma to explain his cabinet decisions. These are things we never thought possible before and they are huge in terms of what authority can do. They set a limit on executive power in the future.”

He also pointed to the Global Competitiveness Index prepared every year by the World Economic Forum, where one can identify a number of positives. Overall, South Africa is ranked 47 out of 138 countries in the index, but in many areas it is rated amongst the most competitive economies in the world.

South Africa is ranked first in terms of auditing standards, protection of minority shareholders’ interests and financing through the equity market. For the soundness of its banks, its legal system, securities exchange regulation and the efficacy of corporate boards it is ranked in the top 10.

“These are things that should bring investors here,” said Els. “There are concerns about politics, but we have this institutional strength.”

However, investors are also very aware of the negatives. Political uncertainty is what is uppermost in most people’s minds, but the poor education system, the burden of government regulation, labour relations and the business costs of crime are all impediments to long-term growth.

“South Africa’s low growth prohibits the ability to bring the budget deficit down,” said Els. “And if that’s a problem, then it’s a problem repaying your debt. So I think the negatives still outweigh the positives, but the positives might prevent Moody’s from dropping South Africa below investment grade.”

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