South Africa

Ratings and Sense: Stormy seas ahead

By J Brooks Spector 17 June 2014

Late last week, two major international ratings agencies pronounced their verdict on South Africa’s economic management – and it wasn’t a particularly pretty picture they found. J. BROOKS SPECTOR takes a first look at what it may mean for the future.

Last week, Fitch and Standard and Poor’s, two of the three major international ratings agencies, took a long, hard look at South Africa’s economic circumstances. They weren’t especially pleased by what they found, giving the country a lowered economic outlook and lowered bond ratings for South Africa respectively. Ouch.

As the Wall Street Journal reported on the decisions, “Standard & Poor’s Ratings Services cut South Africa’s foreign and rand-denominated debt ratings by one notch each, to BBB- and BBB+, respectively, putting the country just above so-called junk-bond status. Meanwhile, Fitch Ratings cut its outlook for the country to negative, a move that indicates the rating firm could be leaning toward a downgrade of the country’s debt later this year. Fitch rates South Africa’s foreign-currency debt BBB, on par with S&P before Friday’s cut. Moody’s Investors Service, the third major ratings company, still maintains a Baa 1, several notches above junk grade.” Previously, all three rating agencies had last downgraded the country’s debt in the six-month period that followed the Marikana killings in August 2012. That event marked the effective beginning of a new round of labour activism in South Africa.

But what are these ratings, and why should anyone pay particular attention to them? Standard and Poor’s describes it own processes, saying, “Credit ratings are opinions about credit risk. Standard & Poor’s ratings express the agency’s opinion about the ability and willingness of an issuer, such as a corporation or state or city government, to meet its financial obligations in full and on time. Credit ratings can also speak to the credit quality of an individual debt issue, such as a corporate or municipal bond, and the relative likelihood that the issue may default. Ratings are provided by credit rating agencies which specialise in evaluating credit risk. In addition to international credit rating agencies, such as Standard & Poor’s, there are regional and niche rating agencies that tend to specialise in a geographical region or industry. Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions. Typically, ratings are expressed as letter grades that range, for example, from ‘AAA’ to ‘D’ to communicate the agency’s opinion of relative level of credit risk.”

Effectively, as S&P explains, such ratings are opinions based on an “analysis by experienced professionals who evaluate and interpret information received from issuers and other available sources to form a considered opinion. Unlike other types of opinions, such as, for example, those provided by doctors or lawyers, credit ratings opinions are not intended to be a prognosis or recommendation.  Instead, they are primarily intended to provide investors and market participants with information about the relative credit risk of issuers and individual debt issues that the agency rates.” In other words, they serve as knowledgeable, trusted, experienced guides for potential investors or sovereign debt purchasers who have to wade through in the thicket of business and economic data and projections.

In evaluating the effect of these most recent downgraded expectations, the WSJ commented, “S&P’s downgrade was widely expected after South Africa’s economy contracted in the first quarter for the first time since 2009. Both S&P and Fitch said the government hasn’t shown it is serious about stopping a wave of disruptive labour strikes that have crimped exports and threatened foreign investment. ‘We do not believe it will manage to undertake major labour or other economic reforms that will significantly boost GDP growth,’ S&P said in explaining its downgrade. Fitch said its shift to a negative outlook was driven by ‘deteriorating trends in governance and corruption.’ ” That sounds pretty ugly, and not at all like a triumphal prelude for the State of the Nation speech President Jacob Zuma will deliver on Tuesday evening.

Given the economy’s shrinkage in the previous quarter – something that occurred for the first time in five years – the two agencies have effectively made their call of expectations that South Africa’s government has yet to demonstrate any real seriousness about bringing to an end a wave of strikes that has put a crimp in exports and led to a slowdown in foreign investment. In its statement announcing its decision, as S&P noted, “We do not believe it will manage to undertake major labour or other economic reforms that will significantly boost GDP growth,” while the Fitch folks said their stable rating but negative outlook determination had derived from the “deteriorating trends in governance and corruption.”

In response to this rather depressing news, South Africa’s Finance Department responded that, yes indeed, it was most definitely “alive to the growth challenges South Africa faces.” And, that it plans to step up efforts “to improve the regulatory environment, reduce the skills shortage and accelerate its infrastructure investment program.” The ratings agencies did not change their findings, however.

Running in background to other economic processes is the country’s increasingly uncertain labour environment. Despite announcements about an agreement in principle, the five-month strike by 70,000 platinum mining workers under the upstart union, AMCU, has not yet come to a conclusive end – and the miners are not yet back at work. Meanwhile, industry estimates are that the strike has cost the platinum companies around $2 billion in lost revenue; the striking miners have lost millions more in foregone wages; and the platinum belt’s other businesses have been significantly and negatively affected as well. Moreover, the strike, regardless of its eventual outcome, has put a palpable hit on South Africa’s export earnings – and the government’s tax receipts.

Of course, the ratings agencies were not expressing a judgement, it is important to note, over the fairness or unfairness of current the current wage structure. Rather, it was the increasingly acrimonious labour climate and its impact on the country’s economic health that concerned them.

But, even as the platinum miners’ strike may finally end soon, an even larger union, the National Union of Metalworkers (NUMSA) – with almost three times as many members as AMCU has – is threatening to down tools in July, if their call for wage increases is not met. This would undoubtedly have a major effect on such sectors as the auto manufacturing industry. As a result, the country’s labour troubles seem to be very far from being over for this period of time. This means the ratings agencies will be watching developments particularly carefully in the near future as a guide to further decisions on ratings.

Overall, analysts argue that labour unrest has now become a key factor in reducing projections of South Africa’s economic growth, down to around 1.7%, a level that is significantly lower than even the admittedly modest estimates that had been projected at the beginning of the year. It should be particularly worrying that numbers like that are substantially lower than the aggregate figure of 5.4% for Sub-Saharan Africa as a region, from the IMF – meaning South Africa’s competitors regionally are moving ahead of it. Meanwhile, a month ago, South African business confidence had dropped to a 14-year low, the purchasing-managers index reached a five year-low in May, and unemployment for people beyond the age of 35 stands at 36% – and there are no signs of it decreasing any time soon.

In her initial response to the ratings agencies, South African Reserve Bank Governor Gill Marcus admitted that many of the nation’s economic wounds are self-inflicted. After the downgrades, she said that the country’s trade and budget deficits will remain hard to rein in while strikes persist, saying, “The domestic economy is facing enormous headwinds, many of which are of our own making”.

Meanwhile, in its own separate response, the National Treasury commented, “At the outset, government acknowledges the negative impact that the strike has had not only on mining output, but also on industries that have linkages to the sector as suppliers of goods and services and those that process raw materials supplied by the affected mines. It is for this reason that government did everything in its power to support efforts aimed at resolving the strike. Further, notwithstanding the announcement by S&P, government’s ability and commitment to service its debt has not changed.”

The Treasury went on to remind that the foreign portion of the country’s debt is under 10% of the total amount of South Africa’s national debt, the country continues to hold sufficient foreign currency deposits to meet its needs, and that whenever the country needs to access foreign capital markets, it can do so. Putting the best face on things, the Treasury was at pains to assure its critics and debtors both that whenever its bonds are sold, “domestic investors usually find them to be an attractive asset class, especially when the other market dynamics such as the exchange rate and bond price adjustments come into play…. This is attributed to the depth and liquidity of South Africa’s capital market, which has enabled us to raise funding during the toughest of times. But we are not complacent.”

The Finance Department statement went on to say it remained “alive to the growth challenges South Africa faces,” pledging to redouble efforts “to improve the regulatory environment, reduce the skills shortage and accelerate its infrastructure investment program.” Many of these efforts are, however, dependent on political responses that would impact upon an often-lacklustre bureaucracy, a task well that would seemingly be well beyond the immediate ability of the National Treasury to affect.

And what of that political response? While President Zuma has pledged both a strong economic growth imperative under the National Development Plan simultaneously with a yet-to-be-defined “radical socio-economic transformation” during his second term of office, his closest political allies now acknowledge any such transformation would also need to tamp down on the strike season now retarding economic growth. But as ANC Secretary-General Gwede Mantashe recently stated, “All the other interventions will not be taken seriously if the state cannot deal with a strike that is not only putting pressure on the employers but starving workers to death.”

After the ANC’s recent NEC lekgotla, Deputy President Cyril Ramaphosa had said,  “I want to underline two points arising from these reports. First is that the 2014 Manifesto Priorities are funded. This includes the funding of the National Infrastructure Programme of the country. The second point is that the country is going through difficult economic circumstances. The NEC underlined the damaging effects of workplace conflict, especially the long drawn-out strike in the mining industry and how it has contributed to the contraction of the economy in the first quarter of 2014. We can no longer credibly plead insufficient information, lack of experience, slow bureaucracy or any other reason for failing to heed the cries of our people, which we clearly heard during the election campaign. This is the moment clearly and practically to demonstrate to our people that we have heard them; that we are humbled by the mandate they have given us; and that we shall move South Africa forward, faster.” These may well be very fervently held feelings, but a call to vigorous action, perhaps not, however.

In an ideal world, if the government were truly serious about addressing the overall investor climate and deeply affecting the national economic landscape in a positive manner, a detailed, specific, precise, emphatic response would be the core of the president’s State of the Nation speech on Tuesday. But it is more likely there will be yet another business as usual presentation and roll call of programs planned and proposed. The lack of unanimity on economic management among government agencies; the lack of any real enthusiasm for the National Development Plan on the part of the ANC’s tri-partite partners; the seeming inability to address economic bottlenecks such as the need for active measures to produce trained, skilled manpower for real employment; an unwillingness to address forcefully the underlying causes for the current climate of labour strife; and a reluctance to rein in government spending on non-essentials will, more than likely, underscore a reluctance to tackle the fundamentals that have already been highlighted by the ratings agencies in their judgements.

As Moneyweb commented just as the two ratings agencies were poised to deliver their respective verdicts, “…investors are worried that President Jacob Zuma, re-elected for a second five-year term last month despite rising discontent among his working class support base, might loosen the purse strings to boost the flagging economy and create much-needed jobs. ‘It does not change the fact that South Africa may have a labour relations issue that could cloud the growth outlook that has impacted on investor confidence in the country,’ said London-based Standard Chartered economist Razia Khan. ‘What the ratings agencies will be focused on are the structural issues in South Africa. It’s the medium to long term, and the day-to-day news flow doesn’t change that.’ ”

And in reporting on the downgrades and the country’s response so far, the Financial Times quoted S&P as saying, “While South Africa’s fiscal out-turn has held up so far, the fiscal stance over the next few years may become exposed to lower-than-expected economic growth, pressures from a new round of public-sector wage negotiations and increased public spending needs.” The Financial Times cautioned, moreover, that as Jacob Zuma entered his second term of office, “sceptics question whether his new administration will tackle the country’s pressing social and economic challenges with the required vigour and with greater coherence than his previous government. When Mr Zuma announced his new cabinet last month, the business had been looking for a more streamlined government. Yet Mr Zuma actually increased the number of ministers to 35 and made several appointments that have been questioned by business executives.”

If the government follows indications so far, South Africans can likely look forward to simplistic exhortations on the need to reduce youth unemployment and build national cohesion as ways out of the country’s current difficulties. This would be consistent with ANC party spokesman Zizi Kodwa’s statement in which he exhorted South Africans to help grow the economy after ratings agency Fitch had changed its outlook on SA’s credit rating to negative. Rather than specifics, Kodwa said, “The ANC calls on all South Africans to work with us and the ANC government to grow this economy for the benefit of all South Africans”.

But if this lack of fierce urgency continues as the real tenor of responses to the national condition, South Africa may well look forward to the real possibility of further downgrades or yet more strongly negative outlooks on the part of those international ratings agencies in future. And that, in turn, would lead to the squeeze of higher credit costs for the country as a whole, as well as on the costs of borrowing (including housing bonds, car loans, credit card debt, and unsecured loans) for individuals purchasing almost anything. Higher costs of government borrowing, of course, also put sharper limits on the government’s ability to finance expenditures – including the vast infrastructure spend now being contemplated. Combine that with the consequences of policy drift and a government-as-usual demeanour, and this may become a recipe for serious economic stormy weather dead ahead. DM

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Photo: A photograph made available on 10 June 2013 shows power lines running to a coal power station in the early morning light near Johannesburg, South Africa, 06 June 2013. EPA/KIM LUDBROOK

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