Fitch revises South Africa’s credit rating

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By Kevin Lings

Fitch Ratings has revised the outlook for South Africa’s long-term foreign currency rating of ‘BBB+’ from Positive to Stable.

According to Fitch, “the revision of the outlook reflects a reassessment of South Africa’s medium-term potential growth prospects as supply side constraints have become more visible in 2008 and more challenging international economic and financial conditions. Rising inflation, a wide current account deficit and political uncertainties are creating a testing environment for policy makers.”

The following is a summary of Fitch’s comments:

GDP growth momentum slowed significantly in Q1 2008 to 2.1% on a seasonally adjusted annualised basis, due to severe disruptions to energy supply. But more generally, growth is slowing due to the impact of rising interest rates on consumer demand, and a less benign global environment. Although South Africa’s public investment programme will continue to underpin demand growth, tighter monetary conditions are already taking their toll on consumer spending. Electricity supply constraints and other infrastructure bottlenecks will limit growth potential until at least the end of the decade.

Inflationary pressures worsened over the past year due to global food and fuel prices and a weaker rand. The South African Reserve Bank has increased interest rates by 300 basis points over the past year, taking the total increase to 500 basis points since June 2006. Given ongoing global inflationary pressures, the impending rise in electricity tariffs and higher wage expectations, the SARB does not expect to bring inflation back within the target range until Q3 2010. This means that interest rates will need to remain higher for longer than previously expected in order to anchor inflation expectations, with adverse implications for growth.

The current account deficit was also boosted by rapid demand and credit growth over 2006 and 2007 but remains high even though consumer spending has slowed, reflecting its increasingly investment-driven nature. However, adverse global investor sentiment coupled with the domestic energy shock and increased political uncertainty, has made its financing more problematic. Cumulative net equity portfolio inflows (the prominent source of financing in the last two years) have been negative so far this year, resulting in a depreciation of the currency. Financing of the current account deficit remains a risk to the macroeconomic outlook. Fitch expects a much higher reliance on borrowing by the private sector and public corporations to finance the current account deficit, resulting in a worsening of gross external debt ratios. Nevertheless, starting from a comfortable position, gross debt ratios are forecast to remain moderate over the medium-term and provide support to the rating.

Public finances remain an important strength for the rating. The worsening growth outlook and cost pressures will negatively impact the 2008 budget, which Fitch expects to result in smaller surpluses or small deficits over the medium term, rather than the projected surpluses. Nevertheless, public debt continues to decline to below the ‘BBB’ median and could fall as low as 21% of GDP in 2010 from 27% in 2007. However, the energy crisis has fiscal implications. In support of Eskom’s massive capital spending programme, the government has committed ZAR60bn (2.7% of 2008 GDP) over five years to allow Eskom to borrow based on the strength of its balance sheet. This is included in the government’s budget projections. As a result of upward revisions to Eskom’s capital expenditure, the public sector borrowing requirement will increase to a still modest yearly average of 1.4% of GDP over the medium term from 1% in the previous budget.

Private credit growth is moderating with a more marked effect on household credit items, such as instalment sales and leasing credit. House prices have also started to fall. Bank NPLs are rising and banks’ earnings growth is expected to slow. However, the banking system is expected to be able to manage the impact of the economic downturn.

Fitch expects South Africa to continue to experience political uncertainty due to the ongoing transition to the new ANC leadership, as well as the impending corruption trial of the ANC president and likely future president of the country, Mr Jacob Zuma. Although Fitch does not expect a fundamental shift in policy, these factors are likely to affect investor sentiment until at least after the general elections in April 2009 and the trial is resolved.

Overall, Fitch believes South Africa’s sound fundamentals in terms of fiscal surpluses, strong public debt dynamics, higher reserves, moderate external debt and the flexible exchange rate and inflation targeting framework leave the country well placed to manage the impact of adverse shocks and support its current rating of ‘BBB+’.

While this is not a formal downgrade, the move from a ‘positive outlook’ to a ‘stable outlook’ is obviously negative in that it suggests it will be some time before Fitch awards South Africa an ‘A’ rating. Fitch upgraded to BBB+ on 25 August 2005 and during 2006/2007 it was hoped that the rating would be moved up to an ‘A’ rating.

While it is clear that the general economic environment has deteriorated, we had expected the rating to be left unchanged and the positive outlook maintained. (I met with the Fitch rating agency delegation and National Treasury on 5 June). I suspect the latest current account deficit of 9% of GDP, coupled with the increased political uncertainty and difficulties surrounding Eskom, led to the revision to the rating outlook. This is effectively the first step backwards South Africa has experienced in the rating process since Fitch gave the country its first international credit rating on 22 September 1994.


Source: Kevin Lings, Stanlib, June 18, 2008.


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