Johannesburg - Rating agency Standard and Poor's (S&P) downgrading South Africa's long-term foreign currency rating was significant, Old Mutual said on Saturday.
“As expected, S&P cut South Africa's long-term foreign currency credit rating to BBB-, citing the weak economic growth outlook,” chief investment strategist for Old Mutual's wealth division Dave Mohr said in a statement.
“S&P cut South Africa's GDP growth forecast for 2014 to 1.9 percent from 2.7 percent. This is slightly better than Fitch's forecast of 1.7 percent, but still represents a significant downgrade of the country's growth prospects.”
On Friday, S&P said the downgrade reflected their expectation that gross domestic product (GDP) growth in South Africa would be lacklustre.
This was against a backdrop of relatively high current account deficits, rising general government debt, and the potential volatility and cost of external financing, the agency said in a research update.
According to S&P, BBB means a government has “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”. BBB- is considered the lowest investment grade by market participants.
Mohr said the slower growth was expected to limit government's ability to raise tax revenues.
“S&P expressed concern over pressure from the next round of public sector wage negotiations,” he said.
“More specifically, S&P, like Fitch, has serious doubts whether government is committed to the necessary reforms to raise the country's growth rate - particularly in terms of labour relations.”
However, both ratings agencies believed the policies of the new administration would be broadly in line with past policies.
S&P also expressed concern over the high current account deficit, which has not narrowed significantly despite the weak economy.
“The protracted strike in the platinum sector - which hopefully appears to be near a resolution - and other sectors are also of major concern,” said Mohr.
“Because the issues raised by S&P were clearly flagged in December already, and widely known, the downgrade was not a surprise. Therefore short-term market reaction will probably be muted.”
The longer-term outlook was more concerning as South Africa was only one notch above “junk” status.
“If we do not get growth going and make headway in closing the budget and current account deficits, a further downgrade is likely,” Mohr said.
“This will probably put significant upward pressure on long-term bond yields and downward pressure on the currency as several foreign institutional investors will not be allowed to hold our bonds in terms of their mandates.”
Higher government bond yields would translate into higher borrowing costs for the private sector, potentially weakening growth and thus setting off a negative spiral. - Sapa