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South Africa

EM Monitor - Investing in South Africa

September 2019

South Africa's economy under pressure 

A possible downgrade by Moody's could compound South Africa's economic difficulties, as Sabrina Khanniche explains.

As suggested by the historical relationship between our proprietary public debt sustainability score1 and the agency’s rating moves (see Fig.1 below), there are chances that Moody's may downgrade South Africa to non-investment grade on 1 November.

A downgrade of South Africa by Moody's could materialise
Fig.1 - Pictet AM public debt sustainability score1 vs. Moody's (2018)
Fig.1 - Pictet AM public debt sustainability score1 vs. Moody's (2018)

Source: Pictet Asset Management, CEIC, Refinitv, Bloomberg; September 2019.

Moody’s is the only major credit rating agency that has not yet given the country a non-investment grade status. Fitch Ratings and S&P Global cut the country’s credit rating to ‘junk’ back in April 2017 when Pravin Gordhan was dismissed as finance minister.

In this context, we look at the growing debt and financing challenges South Africa is facing.

Debt - South Africa's ailing point

The country displays weak debt dynamics1, especially versus its peers, as illustrated below.
South Africa's debt dynamics does not bode well vs. other EM countries
Fig.2 - Pictet AM public debt sustainability score1 vs. Moody's ratings (2018)
Fig.2 - Pictet AM public debt sustainability score vs. Moody's ratings (2018)

Source: Pictet Asset Management, CEIC, Refinitiv, Bloomberg; September 2019.

Its ability to reduce debt through economic growth is limited, as shown by the highly negative growth/interest rate differential illustrated in Fig.3a below.

Also, the debt-finance ability (i.e. the funding capacity of the private sector) remains weak due to disappointing economic growth, resulting in lower government revenue collection. Our leading growth indicator does not suggest any pick-up going forward, as shown on the right.
Bleak picture in terms of the country's debt-finance ability
Fig.3a (left) - Nominal GDP growth less interest payments (2018) / Fig.3b (right) Pictet AM leading index growth
Fig.3a (left) - Nominal GDP growth less interest payments (2018) / Fig.3b (right) Pictet AM leading index growth

Source: Pictet Asset Management, CEIC, Refinitiv, Bloomberg; September 2019.

SOEs adding to the troubled economy...

The situation is set to worsen with state-owned enterprises (SOEs) requiring cash injections. Indeed, the government recently announced additional support to Eskom, the largest electricity company2, of ZAR 59 billion (USD 4 billion) through the end of the 2020/21 fiscal year. This is on top of the ZAR 230 billion bailout funds already allocated in this year's budget for the next ten years3.

Other SOEs are at risk, such as South African Airways, South African Broadcasting Corporation and Denel4, and may soon require emergency funding.

A downgrade by Moody's - the last straw for South Africa

A downgrade by Moody’s would increase South Africa’s already high external vulnerability, as evidenced by the country's current account deficit.

Financing needs remain high and are increasingly met with Portfolio Investment (i.e. investments made by investment funds which often have credit rating constraints), generally a more volatile financing source than Foreign Direct Investments (FDI).

Fig.4a (left) - Balance of Payments / Fig.4b (right) - Deviation of the South African rand (ZAR) from equilibrium
Fig.4a (left) - Balance of Payments / Fig.4b (right) - Deviation of the South African rand (ZAR) from equilibrium

Source: Pictet Asset Management, CEIC, Refinitiv, Bloomberg; September 2019.

We also believe a downgrade to non-investment grade would trigger capital outflows. This could in turn lead to a depreciation of the currency, especially as the South African rand is nearly the most overvalued currency in emerging markets, as shown in Fig.4b above.
South Africa’s economy has been ailing, getting worse over time with rising needs for foreign financing. As things stand, we don’t believe in the country’s ability to decrease its debt burden, especially with lackluster economic growth, also illustrated by the growing number of SOEs seeking financial support. A downgrade by Moody’s as a non-investment grade on 1 November would certainly make the situation even harder for the country to handle. Strong measures by the Ramaphosa government are urgently needed for a change.
outh Africa’s economy has been ailing, getting worse over time with rising needs for foreign financing. We don’t believe in the country’s ability to decrease its debt burden, especially with lackluster economic growth, also illustrated by the growing number of SOEs seeking financial support. A downgrade by Moody’s as a non-investment grade on November 1st, which we expect to happen, would certainly make the situation even harder for the country to handle.