“Stagnating economic growth, translating into slowing employment and income growth, has made it tougher for the country’s household sector to make further much needed financial improvements in terms of reducing its debt-to-disposable income ratio and raising its savings rate,” revealed John Loos, First National Bank (FNB) Home Loans household and property sector strategist.
According to the third quarter 2015 quarterly bulletin released by the South African Reserve Bank (SARB), South Africa’s household debt-to-disposable income ratio increased slightly in the third quarter to 78.3% from 77.7% in the previous quarter.
While the economy continues to stumble, last week saw rating agencies Standard & Poor’s (S&P), and Fitch Ratings, giving South Africa a BBB- credit rating, with S&P changing South Africa’s outlook from ‘stable’ to ‘negative’.
SA’s credit downgrade
The downgrade of South Africa’s credit status now has the country’s economy sitting just above junk status. If the country reaches junk status, it limits the number of foreign investors who can invest in a country as they are restricted from investing in junk bonds.
However, the downgrading of South Africa’s credit rating did not come as a surprise. In a statement, Overberg Asset Management (OAM) stated: “As anticipated Fitch credit rating agency downgraded SA’s sovereign foreign currency debt rating from BBB to BBB- just one notch above speculative grade or “junk status”. The downgrade had been expected bringing the Fitch rating in line with the rating of Moody’s and Standard & Poor’s.
“Surprisingly, Standard & Poor’s (S&P) in its biannual credit review replaced its “stable” outlook for SA’s credit rating with a “negative watch.” A negative watch normally precedes an actual downgrade and in this instance paves the way for a downgrade to speculative grade. S&P cited weakness in economic growth as the key reason for the change in outlook and warned that a downgrade could follow if growth underperformed its modest expectations of 1.6% growth in 2016 and 2.1% growth in 2017,” added OAM.
There were a number of factors which led to Fitch downgrading South Africa to BBB-. These include the country’s electricity constraints, as well as a lack of delivery with regards to material improvement in the business environment and medium-term growth prospects.
“Electricity constraints have eased somewhat, with virtually no load shedding reported for recent months and the prospect of no load shedding until May 2016 according to Eskom. However, the timeframe for new power capacity has suffered further setbacks. A first generating unit at the Medupi plant came online in August 2015, but additional units at Medupi and Kusile will only gradually be completed from 2018 onwards,” said Fitch.
S&P had previously rated South Africa at BBB-, however, the country’s outlook was ‘stable’. As of 4 December 2015, S&P revised its outlook to ‘negative’.
In explaining its decision, S&P said: “South Africa's pace of economic growth remains slow. External demand is weak, with low commodity prices, and the country faces domestic constraints including an inadequate electricity supply and overall weak business confidence inhibiting substantial private sector investment.
“Nevertheless, the National Treasury is broadly maintaining its prudent fiscal consolidation through hard expenditure ceilings. We forecast fiscal deficits to gradually reduce, with net debt stabilizing at around 45% of GDP over 2015-2018.”
Furthermore, S&P noted: “We estimate that the current account deficit will have been smaller in 2015 than in 2014 owing to lower oil prices, weak domestic demand, and import compression from the weaker rand, while external portfolio inflows have remained fairly stable. We expect external deficits will moderately increase in the next few years as the economic environment improves. The country's financing will remain subject to changes in investor sentiment.
“We are therefore revising the outlook on South Africa to negative from stable, and affirming our 'BBB-' foreign currency and 'BBB+' local currency ratings on the country.”
Is a future downgrade on the horizon?
S&P have noted that a future revision in South Africa’s outlook, either positive or negative, will be dependent on a number of factors.
“The negative outlook reflects our view that GDP growth might be lower than we currently expect; for instance, due to persistent electricity shortages, continued weak business confidence, or labour disputes escalating again. The outlook also reflects our view that fiscal flexibility might reduce owing to contingency risks from state-owned entities with weak balance sheets.
“We could lower the ratings if GDP growth does not improve in line with our current expectations, or if state-owned enterprises require higher government support than we currently expect,” explained S&P.
The rating could also be lower “if external imbalances increase, or funding for South Africa's current account or fiscal deficits becomes less readily available. A reduction in fiscal flexibility could also lead us to lower the local currency ratings, potentially by more than one notch,” added S&P.
However, if S&P observe a policy implementation that leads to improved business confidence and increased private sector investment, contributing to higher GDP growth, it revealed that it could revise the country’s outlook back to stable.
What impacts a credit rating?
The following risk factors, individually or collectively, could trigger negative rating action, according to Fitch:
- A loosening of fiscal policy, such as upward revisions to expenditure ceilings, leading to a failure to stabilise the ratio of government debt/GDP.
- Further marked weakening in trend GDP growth, for example due to a lack of policy changes to improve the investment climate.
- Rising net external debt to levels that raise the potential for serious financing strains.
In comparison, Fitch pointed out that the following risk factors, individually or collectively, could trigger positive rating action:
- A track record of improved growth performance, for example bolstered by the successful implementation of growth-enhancing structural reforms.
- A marked narrowing in the budget deficit and a reduction in the ratio of government debt/GDP.
- A narrowing in the current account deficit and improvement in the country's net external debt/GDP ratio.