S&P delivers a pre-emptive strike on SA’s credit ratings, downgrading hard currency rating to sub-investment grade and local currency to the last notch of investment grade.

Last night Standard & Poor’s (S&P) acted on the negative outlook it had previously placed on SA’s sovereign debt, dropping SA’s long-term foreign currency credit rating to BB+ (from BBB-), and the long-term local currency rating to BBB- (from BBB).

In addition, with a negative outlook placed on both ratings, S&P signalled further downgrades were far from over, stating “political risks will remain elevated this year, and … policy shifts are likely, which could undermine fiscal and economic growth outcomes more than we currently project.”

Having lost its S&P headline country investment grade rating, SA is now at greatly increased risk of losing its S&P local currency investment grade rating (as it is now BBB- with a negative outlook), and so at risk of a much more difficult path of fiscal consolidation.

While rand-denominated issuance is around 90% and hard currency 10%, the downgrades will raise borrowing costs, undermine investor confidence, likely reduce the attractiveness of SA bonds at auction, and so negatively impact SA’s ease of funding. This, in turn, will have a negative impact on SA’s government finances.

S&P added “The downgrade reflects our view that the divisions in the ANC-led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk. This has increased the likelihood that economic growth and fiscal outcomes could suffer. “

Higher borrowing costs increase the cost of repaying government debt, and without a substantial, and sustainable curtailment in government expenditure and rise in revenue, increase the chance of further credit downgrades. Upwards pressure is placed on interest rates (weaker economic growth) and rand weakness (as investors lose confidence and sell SA portfolio assets) which exacerbates the situation, reducing further government’s capacity for expenditure, including existing social welfare grants.

S&P identifies that “Internal government and party divisions could, we believe, delay fiscal and structural reforms, and potentially erode the trust that had been established between business leaders and labor representatives (including in the critical mining sector). … We think that ongoing tensions and the potential for further event risk could weigh on investor confidence and exchange rates, and potentially drive increases in real interest rates.”

SA’s net debt has risen from 22% of GDP in 2008/09 to 46.0% of GDP in 2016/17, and is scheduled to rise to 48% of GDP in 2019/20. If government ignores the trend and fails to reign in mounting debt and return it closer to 40% of GDP then the rating agencies perceived creditworthiness of SA debt (SA’s sovereign credit ratings) will likely fall further. It will likely take several years for South Africa to regain its investment grade country rating from S&P.

Borrowing to pay current expenditure (including debt service costs) risks a debt trap developing, and such a downward spiral risks ultimate debt default, whether it’s an individual or sovereign. Such sovereign bankruptcy risk (failed state) is exacerbated by credit rating downgrades clearly, as credit rating downgrades increase the cost of servicing debt.

S&P has also warned that “(t)he rating action also reflects our view that contingent liabilities to the state, particularly in the energy sector, are on the rise, and that previous plans to improve the underlying financial position of Eskom may not be implemented in a comprehensive and timely manner. In our view, higher risks of budgetary slippage will also put upward pressure on South Africa’s cost of capital, further dampening already-modest growth.”

S&P’s downgrades have occurred outside the scheduled country review calendar. However, such has been the perceived severity of the recent political events that the agency has acted now between reviews on “the heightened political and institutional uncertainties that have arisen from the recent changes in executive leadership”. Moody’s has signalled it could also move sooner on a downgrade than its planned 7^th April. Fitch tends to be aligned with S&P, and so could also provide a sub investment country credit rating for South Africa this year.

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