Last week was a terrible one for South Africa.
Officials spun President Cyril Ramaphosa’s annual investment conference last week as a success that would result in large flows into the country. Yet in reality there were no investors lining up to invest in mega new steel, vehicle, mine, or agribusiness projects.
The absence of new greenfield mega-investment projects should in itself be a warning that the South African investment conference was a case of putting the cart before the horse. Without cutting government debt, solving load shedding problems, loosening empowerment rules, and deregulating the economy to make for a far more business-friendly environment there is no persuasive story that the country can tell investors.
Ratings agencies made their call
Just days after the investment conference, the verdict delivered by the credit rating agencies on South Africa’s overall direction of travel was much the same. Two of the big three agencies, Moody’s and Fitch, pushed South Africa’s credit rating further into junk status with a negative outlook that points to further downgrades. South Africa now has the lowest credit rating since 1994 and none of the agencies see things improving in the medium-term.
Earlier this year South Africa was pushed down into junk status, which means certain investment funds cannot invest in South African government debt. Last week Moody’s downgraded South Africa to Ba2, the second tier down on the junk ladder, and that came with a negative outlook pointing to future pushes down the ladder. Fitch gave it a similar rating on its ladder of junk status. The job of credit rating agencies is to assess the ability of, in this case, the government, to service its debt over the medium term.
Ratings are lagging indicators of the economic state of the country, but if they fall, they ultimately point to higher borrowing costs for the state by signaling an all-in-one risk assessment of an investment destination. With the possibility that Covid-19 vaccines will be rolled out sooner rather than later, and the US election over, investors are now more prepared to take on greater emerging market risk. That is why the Rand, which largely tracks other emerging market currencies, held its own after the rating downgrade. Besides, for the moment, the traders like the high yields on SA bonds, although they worry about taking on too much longer-term South African debt.
The country is being forced to borrow for a shorter term at higher rates, With tax revenue collapsing in the wake of the lockdown and South Africa’s interest bill rising fast, the concern is that South Africa will at some point not be able to borrow sufficiently to service debt. For the moment it is not too bad in the markets for South Africa.
The prime reason for the downgrades last week is the view that South Africa lacks the ability to take the necessary measures to consolidate government finances and grow the economy. South Africa is not alone in having been battered by the Covid-19 crisis, but it’s capacity to deal with the shock is lower than many other countries due to what Moody’s says are, “significant fiscal, economic and social constraints and rising borrowing costs.”
While the economy is rebounding from the pandemic lockdown and will come off a low base next year to show a growth rate of 4.8 percent, Fitch expects that to be a one-off bounce, and in two years it will return to around 1.5 percent. Investment spending has slumped in recent years and last year was at the lowest level since 2012, which does not bode well for future growth.
The rating agencies say the government fiscal consolidation plan is unconvincing and relies heavily on freezing public wages, which is unlikely to happen. Fitch says it expects that the budget deficit will rise from 16.3 percent in this fiscal year, to well over the Treasury’s latest projection of 15.7 percent. It says the government will be forced to reverse its decision not to pay a wage increase to the public service for the current fiscal year. Picking a fight with union allies by freezing pay will be very difficult, with the local government elections coming up next year and the uncertain state of play within the ANC.
The difficulty in cutting spending was highlighted over the past week with a strike by taxi drivers, resulting in blockages of highways to support their demands for additional Covid-19 support. Will the government stand up against the taxi drivers as they force traffic to a halt?
Government’s overall determination to cut spending is also questionable. Continued free flights for former ministers, some of whom left office under a cloud, has to be wasteful spending. The employment of Cuban mechanics to work on Defence Force trucks has yet to be fully explained. Salaries paid by the SABC, which is now in financial distress, are way above market benchmarks, but have continued for years. And then there is the continued bailout of SAA. In this case it might be best to pay the once-off closure payment and get out of the business rather than endure endless calls on the public purse. What other items of excess are hidden away in government departments and state-owned enterprises?
Poor track record
While there is a reform plan and the President’s Economic Reconstruction and Recovery has been laid out, the track record on implementation has been weak in the past and Fitch says: “Even if implemented, the effect of the reforms would be limited and take time to accumulate.”
Moody’s thinks needed changes are unlikely due to “economic and social constraints.” A translation of that is that necessary reform under the ANC is highly improbable.
South Africa’s proposed reforms still fall short of what is required, both agencies say. Missing is labour market reform to rid the market of rigidities. That might be regarded as a cliché used by the IMF and the rating agencies, but it is one repeated by investors who don’t like the centralised bargaining process. The result is the imposition of a wage structure on all firms. The result is a built-in creator of unemployment, which is likely to grow in the aftermath of the Covid-19 shock.
How to change the view
What could change the view of the rating agencies?
Moody’s says they could give a stable outlook, which implies that the rating is likely to remain the same, if there was a durable pickup in growth, partly due to “meaningful and effective labour market or power sector reforms, and a steadily narrowing fiscal deficit. On the fiscal side, an agreement with the unions which substantially moderates future increases in the wage bill would also be supportive.”
The year ahead will test the ANC’s ability to achieve that. The Treasury’s response to the downgrades was to say increased hardship would result from the downgrades, but “growth-enhancing strategies in order to rectify the accumulation of debt” need to be fast-tracked.
But later, Finance Minister Tito Mboweni tweeted that the rating agencies were unfair and were violating the Queensberry Rules, by hitting someone who was down “during a global crisis.”
To maintain their credibility, the rating agencies have no option but to call what they see. South Africa’s best option would be to prove the rating agencies wrong and deal with its ‘own goals’ that have pushed us deep into crisis.
The views of the writer are not necessarily the views of the Daily Friend or the IRR
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