Johannesburg - South Africa’s fiscal constraints will be put under the spotlight this week as two of the world’s credit ratings agencies announce the outcome of their review of the country’s financial outlook.
Fitch is increasingly seen leaning towards downgrading South Africa to one notch above the so-called junk or non-investment grade.
The downgrade will bring Fitch broadly in line with where Standard & Poor’s (S&P) rating is currently, while Moody’s – which maintains a stable outlook on South Africa – is one notch above S&P.
But what is likely to worry investors more are the growing signs that South Africa is fast running out of fiscal space as economic growth remains stubbornly weak, raising the risk of the country eventually losing its investment grade status if there is no course correction.
Begin liquidating
A junk rating will not only raise the country’s borrowing costs, but it will also force investment funds that hold South African debt to begin liquidating their holdings since their rules prevent them from holding non-investment grade assets.
Both Fitch and S&P are scheduled to release their reviews on Friday.
Their pronouncements could also put pressure on the rand. The currency’s volatility was one of the reasons why the SA Reserve Bank was forced to raise interest rates more than a week ago.
Fitch has South Africa’s long-term local currency sovereign rating at BBB+ and foreign currency sovereign rating at BBB, with respective negative outlooks.
“The agency is relatively negative on South Africa overall, and will likely downgrade these ratings, if not this year, then next,” Investec chief economist Annabel Bishop said.
She said Fitch’s current negative outlook on South Africa’s issuer default ratings signalled a future downgrade on weak growth and a failure to boost growth potential.
She noted that S&P had commented recently that if the government did not demonstrate fiscal discipline, a reduction in the country’s sovereign rating could eventually be on the cards, and its view was that the country was on the “wrong economic track”.
Peter Attard Montalto, an emerging market economist at Nomura, however, said a week ago that he did not see South Africa sliding into a non-investment grade just yet. He said: “The hurdle for a shift towards sub-investment grade (even an outlook change) for S&P is simply too great and wider than fiscal.
“For Fitch, a downgrade (it is on negative watch) from BBB to BBB- is possible on low growth and fiscal worries, but less likely,” he added.
Montalto said Fitch might even wait for Finance Minister Nhlanhla Nene’s February Budget to determine the next course of action.
Even so, the market will look for the agencies to give some clarity on Friday, more so after recent figures from Statistics SA showed that the economy had narrowly averted recession in the third-quarter as a rebound in manufacturing offset persistent weakness in mining and agriculture.
Contraction
Gross domestic product (GDP) expanded by 0.7 percent after a 1.3 percent contraction in the second quarter. The Reserve Bank has slashed its growth forecasts for this year and 2016.
Weak growth presents Nene with an even more challenging backdrop, as faltering growth means less tax revenues and increased borrowings to plug holes in the budget deficit.
In turn, this means more pressure on the rand as the country becomes increasingly more reliant on foreign flows to finance the current account deficit.
Even so, Reserve Bank deputy governor Francois Groepe said on Friday that the recent depreciation of the rand did not pose an immediate threat to the country’s financial stability.
He said there was no denying the impact of the prolonged period of near-zero US short-term interest rates had had on global economies, as well as financial markets.
Groepe said the extent to which these measures had reduced long-term interest rates in advanced economies and encouraged capital flows towards emerging markets remained a point of debate.
Expectations are rising for the Federal Reserve to raise interest rates in its next meeting on December 16, the first since 2006, as a result of the US’s economy becoming stronger with a lot more jobs being created in October.
Last week the rand fell to its lowest against the dollar at R14.44, but later rallied to push below R14 before settling back at R14.16.
Similar move
Groepe said one could see two main reasons why a rise in US interest rates could justify a similar move in a country like South Africa.
“First, if the US move reflects an inflationary acceleration in the US economy that looks to be replicated in South Africa; and second, if the US rate increase affects capital flows to South Africa to the point that the rand depreciates significantly and raises domestic inflation,” Groepe said in a speech published on the bank’s website.
Another key development to watch this week: tomorrow the country will see how the economy has fared so far with the release of the purchasing managers index, which will give a clear indication of the GDP outlook for the fourth quarter of this year. The index is expected to show another weak quarter.
BUSINESS REPORT