On Dec. 4, 2015, Standard & Poor's Ratings Services revised the outlook on the Republic of South Africa to negative from stable. We affirmed the long- and short-term foreign currency sovereign credit ratings on the Republic of South Africa at 'BBB-/A-3'. We also affirmed the 'BBB+/A-2' long- and short-term local currency ratings.
At the same time, we affirmed the 'zaAAA/zaA-1' South Africa national scale ratings.
Rationale
The outlook revision reflects South Africa’s still-slow pace of economic growth, which we have revised down further to 1.4% for 2015 from our June estimate of 2.1%. This is due to a combination of weak external demand, with low commodity prices, and domestic constraints including an inadequate electricity supply and overall weak business confidence inhibiting substantial private sector investment. This highlights a prolonged period of low growth for a country with per capita GDP of just below US$6,000 in 2015 and population growth averaging at least 1.5% over the last six years.
We expect GDP growth in 2016 to remain around 1.6% and only increase above 2%
from 2017 as the capacity of electricity supply improves thanks to new power plants. Business confidence may improve if the government takes the necessary steps to improve policy coordination and implement delayed legislation, which may help to bolster the muted private-sector fixed investment.
Economic growth over the next few years will also depend on the absence of prolonged labor strikes, and limited negative spillover effects from the likely U.S. interest rate hikes, or the impact of lower demand from China on commodity prices and export volumes.
We think that President Jacob Zuma's second administration will maintain broad policy continuity, although there have been legislative delays and policy direction still lacks clarity in some areas. Legislation that has been delayed includes items related to mining sector investment, much-needed labor market reforms, trade negotiations, and industry interventions. In our view, this impairs business confidence and ultimately leads to a weak private-sector investment contribution to growth.
While fiscal targets are exposed to the risk of low GDP growth, we expect that a combination of conservative tax revenue forecasts and the hard expenditure ceiling will ensure that the Treasury remains close to its revised fiscal consolidation targets. The 2014/15 fiscal outturn was slightly better than we had expected thanks to tax revenue buoyancy and strong expenditure controls. The 2015/16 budget has facilitated higher revenues through a hike in income tax and fuel levy, while maintaining a strict control on expenditures. We therefore expect the annual growth of general government debt to be just below 4% of GDP on average over 2015-2018, assuming exchange rate fluctuations are more modest.
General government debt, net of liquid assets, increased to 43% of GDP in 2015 from 22% in 2008, and we expect it to stabilize at around 45% by 2017. Although less than 10% of the government's debt stock is denominated in foreign currency, nonresidents hold about 34% of the government's rand-denominated debt, which could make financing vulnerable to foreign investor sentiment. We project interest spending to increase to 11% of government revenues this fiscal year.
We view South Africa's contingent liabilities as currently limited. Nevertheless, in our view, the government faces risks from nonfinancial public enterprises with weak balance sheets, which may require more government support than we currently assume. Eskom, the largest state-owned enterprise that currently requires government support, benefits from a government guarantee framework of South African rand (ZAR) 350 billion (US$25 billion)--about 8% of GDP. Eskom has utilized around ZAR160 billion of this guarantee amount to date. The government is in the process of providing an additional support package in the form of a ZAR23 billion equity injection over three tranches, and it has already converted its ZAR60 billion loan to Eskom into equity. In our view, if Eskom were to fail to secure some of its funding then the government may be expected to do more than currently planned. Other state-owned entities that we consider may pose a risk to the fiscal outlook include Sanral, a national road agency, which we understand faces revenue collection challenges with its Gauteng tolling system, and South African Airways, which faces financial challenges to continue its operations without additional government support. Both entities have a combined
government guarantee framework of over ZAR50 billion (US$3.6 billion), of which they have utilized over ZAR40 billion to date.
The size of the current account deficit has reduced in 2015 owing to the lower price of oil (which constitutes about one-fifth of South Africa’s imports), weak domestic demand, and import compression from the weaker rand exchange rate. Although the rand floats and is an actively traded currency (according to the Bank of International Settlements' triennial survey of foreign exchange dealing, it is traded in 1.1% of global foreign-exchange contracts), the portfolio and other investment flows that finance these deficits can be volatile. Such volatilities could result from global changes in risk appetite; foreign investors reappraising prospective returns in the event of growth or policy slippage in South Africa; or rising interest rates in advanced markets. We expect external debt net of liquid assets will average below 50% of current account receipts over 2015-2018.
South Africa continues to pursue a floating exchange rate regime. The South African Reserve Bank does not have any exchange rate targets or defend any particular exchange rate level. We consider the rand to be vulnerable to the level and direction of portfolio flows between South Africa and the rest of the world and to changes in investor sentiment due to its liquidity and its use as a proxy for emerging-market trades. The South African Reserve Bank has a track record of operational independence, in our view. It uses an inflation-targeting framework for its monetary policy. The bank also uses open market operations to manage liquidity, including to sterilize its purchases of
foreign exchange inflows. The repo rate is the bank's most important monetary policy instrument.
Despite lower oil prices, a weaker exchange rate and higher electricity prices have increased inflationary pressures. The central bank now expects inflation to exceed its 3%-6% target range temporarily in parts of 2016. The bank has started monetary tightening, with the most recent hike of 0.25% in November 2015 providing a cumulative hike of 1.25% since January 2014. Domestic capital markets are well developed, in our view, with depository corporation claims on residents in local currency and nonsovereign bond market capitalization combined accounting for around 20% of GDP. Government bonds account for another 40% of GDP.
The long-term local currency sovereign rating on South Africa is two notches above the long-term foreign currency sovereign rating. This is because we believe that the sovereign's flexibility in its own currency is supported by the independent monetary policy of the the South African Reserve Bank and a large and active local currency fixed-income market.
South Africa remains a middle-income country with a diversified economy and wide income disparities.The ratings are supported by our assumption that South Africa will experience continued broad political institutional stability and macro policy continuity. We also take into account our view that South Africa will maintain fairly strong and transparent macro institutions and deep financial markets. The ratings are constrained by lackluster reform efforts, low GDP growth, volatile sources of financing, the structural current account deficits, and sizable general government debt.
Outlook
The negative outlook reflects our view that GDP growth might be lower than we currently expect; for instance, due to persistent electricity shortages, continued weak business confidence, or labor disputes escalating again. The outlook also reflects our view that fiscal flexibility might reduce owing to contingency risks from state-owned entities with weak balance sheets.
We could lower the ratings if GDP growth does not improve in line with our current expectations, or if state-owned enterprises require higher government support than we currently expect.
We could also lower the ratings if external imbalances increase, or funding for South Africa's current account or fiscal deficits becomes less readily available. A reduction in fiscal flexibility could also lead us to lowerthe local currency ratings, potentially by more than one notch.
We could revise the outlook back to stable if we observe policy implementation leading to improving business confidence and increasing private sector investment, and ultimately contributing to higher GDP growth.
