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Credit downgrade threat remains for South Africa

6th November 2015

By: Bloomberg

  

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South African Finance Minister Nhlanhla Nene side-stepped an immediate credit downgrade with his budget proposals. Still, investors are betting that cuts that will bring the nation’s rating to the brink of junk are just a matter of time.

Fitch Ratings and Moody’s Investors Service, which rate the nation’s debt two steps above subinvestment, are set to bring their assessments in line with those of Standard & Poor’s (S&P) at the lowest investment-grade level, credit default swaps suggest. Another step down would start triggering capital outflows, Nene, 56, told lawmakers on October 21, when he lifted projected debt levels and widened budget-deficit targets in the face of slowing growth.

The cost of insuring South Africa’s dollar debt against default for five years has climbed 58 basis points in the past 12 months to 248, compared with the 142 median of five emerging-market economies with similar ratings at Moody’s and Fitch, and 215 for those rated one level lower.

“The debt metrics that the ratings agencies look at are probably going to put us on the back foot,” Thando Vokwana, a currency trader at FirstRand’s Johannesburg-based Rand Merchant Bank unit, said late last month. “You could see a possible downgrade coming and, in that case, South Africa is so reliant on external funding that it would spell disaster.”

South Africa relies on portfolio inflows to finance a current-account shortfall forecast to average 4.3% of gross domestic product (GDP in 2015 as demand for the nation’s commodity exports slows. Weakening tax revenue is putting pressure on the budget deficit, giving Nene less room to spur an economy close to recession and cut a 25% jobless rate.

Nene cut this year’s growth forecast to 1.5% from 2% and predicted expansion of 1.7% in 2016, down from an earlier estimate of 2.4%. The budget deficit will widen from earlier forecasts, reaching 3.3% in the fiscal year through March 2017 and 3.2% in the following year.

Government debt will reach almost 50% of GDP this year, a threshold government will not cross, Nene said.

Keeping debt in check “could now prove challenging,” Kristin Lindow, a New York-based senior VP at Moody’s, said via email. The rising government wage bill has eroded fiscal buffers, raising the risk of overshooting debt targets, she said. Moody’s has a stable outlook on South Africa’s Baa2 rating, suggesting it will probably not lower the assessment in the next 12 months.

The combination of larger deficits and weaker growth will keep public debt rising as government spending continues to increase, said Fitch, which has a negative outlook on South Africa’s BBB rating, indicating that it may cut the nation’s debt when it publishes its next review in December.

S&P, which rates South Africa’s debt BBB– with a stable outlook, said the economy is not able to create enough jobs to reduce unemployment, feeding antigovernment protests such as last week’s student demonstrations against tuition-fee increases.

Edited by Bloomberg

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