The rating agency Fitch recently revised the outlook on South Africa’s long-term foreign-currency issuer default rating down from “stable” to “negative”. A credit rating outlook indicates the potential direction of the country’s rating over the intermediate term, typically six months.
Fitch pointed to the expected increase in the government debt-to-gross domestic product (GDP) ratio. This would make it more difficult to stabilise public debt. The country’s public debt has been increasing due to lower-than-projected tax revenue growth on the back of weak economic growth and the R59bn bailout for the power utility, Eskom.
South Africa’s long-term foreign-currency government bonds are rated BB+ by Fitch and BB by Standard & Poor’s. This means that the government bond is classified as substantially risky. Moody’s rating is Baa3, representing a moderate credit risk investment grade.
There is no indication that South African will soon curb its historically high and rising debt levels. Credit rating agencies have sounded the alarm about South Africa’s finances over the past five years. They have consistently called on government to stabilise the rising debt-to-GDP ratio, address high unemployment and low economic growth rate, and to restructure state-owned enterprises.
A lack of significant reforms led to the country being downgraded to junk status by both Standard & Poor’s and Fitch in April 2017. Only Moody’s has kept South Africa one notch above junk status. But for how long?
The revision by Fitch is significant. Looking at the experiences of some other countries in Africa as well as Brazil, the data suggests that when two of the three major ratings agencies downgrade a country to “junk”, it usually takes between six months to two years for the final agency to follow suit. Considering that both Fitch and S&P downgraded South Africa two years ago, it is likely that Moody’s will downgrade South Africa soon.
This would see South Africa’s government bond falling out of the Citigroup World Government Bond Index – a major global index that tracks investment-grade debt. All fund managers with investment grade mandates will be forced to offload South Africa’s debt. In turn this would wipe out capital inflows at a time when the country is in need of more foreign investment to close its current account deficit.
What’s happened elsewhere
Circumstantial evidence from other countries that were recently downgraded to unanimous “junk status” shows that the after effects can hasten an economic crisis.
In 2001, Egypt was rated “junk” by Moody’s, then downgraded to junk status by S&P in May 2002, followed by Fitch in August 2002. This was driven by a 10% of GDP budget deficit and a 58.4% of GDP government debt. Egypt has not yet recovered its investment grade rating. Instead it has slid even deeper into junk status as government debt kept rising, reaching 108% of GDP in 2017.
Tunisia lost its investment grade in May 2012 by S&P followed by Fitch and Moody’s in December 2012 and February 2013. The causes were declining economic growth, rising unemployment (reaching 18.9%), widening budget deficit (growing to -5.5% of GDP), and government debt of 47.7% of GDP. After the downgrade, Tunisia’s economic growth is still wallowing below 2%, unemployment remains high, the budget deficit worsened and government debt has risen to 71% of GDP in 2017.
It can be argued that South Africa isn’t easily comparable to other African countries because it raises most of budget from tax and other revenues, has deep and liquid financial markets, and most of its debt is in local currency. A country like Brazil, which has similar characteristics, might offer a more useful comparison.
Brazil was downgraded by Fitch in December 2015, followed by S&P in September 2015 and Moody’s in February 2016. The downgrade was driven by an economic recession of -3.8% and the government deficit rising to over 10% of GDP. After the downgrade, the country’s government debt to GDP ratio rose by 12% to 77%.
The other common characteristic of these countries is that they have all signed up to arrangements with the International Monetary Fund (IMF).
In November 2016, Egypt received a US$12 billion loan from the IMF to support its three-year austerity-based economic reform programme, which included local currency devaluation, fuel and energy subsidy cuts and the introduction of value-added tax.
In June 2013, the IMF granted Tunisia a US$1.73 billion bailout and extended another loan of US$2.8 billion in May 2016. This amount has not been fully disbursed due to lack of progress in implementing agreed austerity measures and reforms.
Brazil last received an IMF bailout of US$30.4 billion between 2003 and 2005. The current political administration has been resistant to an IMF bailout, believing that the economy will rebound once reforms are implemented without external support. The central bank, however, forecasts further declines in economic growth and a rise in debt to GDP ratio to 102% by 2023.
There is growing frustration that the ongoing fractional battles in the governing African National Congress are hampering President Cyril Ramaphosa’s ability to make the difficult reform decisions needed to resuscitate the South African economy and avoid a debt trap. These would include reducing the public sector wage bill, restructuring state owned enterprises (including some privatisation), and cutting state spending.
This political paralysis makes the impact of an impending Moody’s downgrade more apparent. Thereafter, whether or not South Africa will have to seek an IMF bailout will depend on the governing party’s ability to withstand two storms.
The first is the significant social and economic instability that is likely to follow a unanimous downgrade to junk status. The second is the extent to which the governing party can withstand the substantial resistance from the left against an austerity budget.
If these two storms lead to even greater political dysfunction and policy paralysis then, in the near future, the IMF will end up making the tough decisions for South Africa.