Fitch Ratings has affirmed South Africa's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook.
Key Rating Drivers
South Africa's ratings are weighed down by low growth potential, sizeable government debt and contingent liabilities and the risk of rising social tensions due to extremely high inequality. The ratings are supported by strong institutions, a favourable government debt structure, deep local capital markets and a healthy banking sector.
GDP growth was weaker than expected in 1H18, but Fitch expects a recovery of investment after a prolonged period of contraction to drive GDP growth to 2.1% in 2019 and 2020 from 0.6% in 2018. The president in September announced a package of measures to stimulate growth, focused on structural reforms as well as reprioritising expenditure. A revised mining charter has been approved, lowering uncertainty for the sector, but raising regulatory costs compared with the previous regime. Initiatives also include measures to strengthen the telecoms sector, raise competition, reduce bulk transport costs and boost tourism by easing visa requirements. However, in Fitch's view the measures will take time to implement and are not sufficiently far-reaching to raise medium-term potential growth significantly. As a result, potential growth is expected to remain just below 2%. This is well below the historical 'BB' category median of 3.4% and only just above population growth of 1.6%.
Over the medium term, low growth and high inequality could raise the risk of social tensions. They could also lead to pressure for policies that undermine fiscal sustainability. For example, the discussion about land reform, including expropriation without compensation, reflects frustration about a lack of progress on reducing inequality. The government has nevertheless made clear it recognises the risks of land reform and will ensure that associated policies will not negatively affect food security or economic growth. The general election expected for May 2019 is unlikely to lead to a significant change in the direction of economic policy-making.
The medium-term budget policy statement in October included an upward revision of deficit and debt projections, with consolidated national government debt (excluding local government debt of around 1.6% of GDP) now expected to stand at 57.4% of GDP in fiscal year ending March 2021 (FY20/21). The revisions mainly reflected lower value-added tax revenue forecasts and lower economic growth expectations, while the expenditure ceiling, a key anchor of fiscal policy, was maintained. No significant consolidation measures were taken to offset the deterioration, probably reflecting concerns about hurting the economic recovery and potentially political concerns in an election next year.
The authorities' consolidated national government deficit projections are now broadly in line with our forecasts for a deficit of 4% of GDP in FY18/19 and 4.2% in FY19/20 but we expect a slightly stronger consolidation to 3.9% of GDP (government: 4.2%) in FY20/21. We expect general government debt (including local government debt) to rise to 61.1% of GDP in FY20/21, from 54.6% in FY17/18. Debt rose from just 26.5% in FY08/09 largely due to under-performing economic growth. If growth stays below 2% over the medium term, as we currently expect, debt/GDP would remain on an upward trend and rise to 69% of GDP in FY27/28. While the current debt ratio is high relative to the historical 'BB' category median of 49.1%, the low share of foreign currency debt in total debt (10.2%) and the long average maturity of debt securities of 15 years contain exchange-rate and roll-over risks.
The weak financial condition of state-owned enterprises (SOEs) constitutes a significant fiscal risk. The liabilities of non-financial and financial SOEs amount to 12.5% and 2% of GDP, respectively. Non-financial SOEs are in poor financial health, on aggregate running a loss of on average 1% of GDP per year over the last five years. A severe liquidity crisis at Eskom, the national electricity company responsible for the bulk of SOE debt, has eased in the face of key personnel changes and governance improvements. However, the long-term viability of the company remains in question and the utility may formally request direct sovereign support.
South Africa's low domestic savings rate and high reliance on potentially volatile portfolio inflows and significant private-sector short-term borrowing (albeit mostly in local currency) is a source of external risk. This was illustrated by the large depreciation of the rand earlier in 2018 during the global emerging market sell-off. Our expectation for further pressure on emerging markets in 2019 from capital outflows and US dollar strength suggests conditions will remain challenging. The current account deficit is expected to rise to 3.5% of GDP in 2018 and to 3.6% in 2019 and 2020, reflecting the expected recovery of domestic demand, including higher imports of capital goods. However, the fully flexible exchange rate acts as an important buffer. Moreover, financing from deep local capital markets could help compensate if foreign appetite dries up.
Despite weak economic growth, banking sector asset quality has held up with non-performing loans at 3.4% of total loans in June 2018. This reflects solid supervision and prudent lending practices. The collapse of a small mutual bank, VBS, may accelerate progress on establishing deposit insurance and a resolution regime, which would further reduce the risks to the sovereign from the banking sector. However, legislation is unlikely to be approved before 2020.
Derivation Summary
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns South Africa a score equivalent to a rating of 'BBB' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Macroeconomic Performance, Policies and Prospects: -1 notch, to reflect South Africa's weak
growth prospects relative to the 'BB' and 'BBB' category medians, with important implications for public finances and long-term risks to social stability.
- Public Finances: -1 notch, to reflect substantial contingent liabilities mainly from SOEs, exacerbated by challenges to the liquidity and long-term viability of some of the SOEs.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Key Assumptions
Fitch expects global economic trends and commodity prices to develop as outlined in Fitch's Global Economic Outlook.
RATING SENSITIVITIES
The following risk factors could, individually or collectively, result in positive rating action:
- Narrowing in the budget deficit sufficient to achieve a substantial reduction in the government debt/GDP ratio.
- A substantial strengthening in trend GDP growth.
- An improvement in governance standards and financial viability of SOEs.
The following risk factors could, individually or collectively, result in negative rating action:
- Failure to stabilise the debt/GDP ratio over the medium term.
- A further deterioration in South Africa's trend GDP growth rate.
- Rising net external debt to levels that raise the potential for serious financing strains.
