With South Africa’s sixth democratic election having run its course, ratings agency Moody’s expects the country’s new government, once formed, to put forward not just steady policies, but also to continue tackling the country’s main challenges, namely low growth, steadily rising debt, leveraged State-owned entities and weakened institutions.
With President Cyril Ramaphosa affirmed as President, further news regarding the composition of the incoming administration and the policies it will pursue to address South Africa’s key challenges is eagerly anticipated.
According to Moody’s, these challenges are material and principally relate to raising potential growth through reforms that lift productivity, enhance competitiveness and bring forth higher levels of investment, as well as arresting and reversing the gradual rise in the debt trajectory, and rebuilding’s South Africa institutions.
Amid all of this, the ratings agency says South Africa’s challenges remain deep-rooted and that it will take years to deal with.
However, in the interim, Moody’s concedes that the country has important strengths which insulate it somewhat from shocks, which will help to buy time for reforms to emerge and be implemented.
South Africa’s favourable government debt structure, large pool of domestic investors and diversified economy will also continue to count in its favour. Nevertheless, over time, rising debt and sustained low growth will erode these strengths, raising the country’s susceptibility to shocks and undermining its credit profile.
Further, the country’s long-term growth outlook remains weak. Given the difficulty in arresting and reversing South Africa’s long-term decline in growth potential, Moody’s expects the structurally low growth will continue to weigh on the country’s economic strength in the next few years.
The soon-to-be-announced administration’s ability to deal with its challenges, through some combination of higher growth and lower deficits, will determine the evolution of South Africa’s credit profile and rating over the coming years, Moody’s avers.
Compared with peers with similar income levels, South Africa’s real gross domestic product (GDP) growth is lower than that of Columbia and Indonesia. In particular, Moody’s highlights that stalling labour productivity between 2010 and 2018 has weighted heavily on growth, a “marked contrast with the double-digit growth of some peers”.
Weak gross capital formation partly accounts for weak productivity growth, Moody’s explains. It points out that investment fell to 17.9% of nominal GDP in 2018 from 23.2% in 2008, one of the lowest shares among Baa2-Ba rated emerging markets.
Brazil, it notes, experienced a similar decline in the share of fixed investment over the same period, to 15.4% from 21.6%, when the “lava jato” corruption investigation undermined business confidence and caused major construction companies to suspend their operations.
Moreover, a lack of reform in the business environment over the past decade saw South Africa’s ranking on the World Bank’s Doing Business survey fall to eighty-second out of 190 countries in 2019, from thirty-fourth in 2010.
“We expect the government will continue to pursue greater control of corruption or State capture and reform policy, which will support a gradual recovery in growth,” Moody’s comments.
Reform measures are expected to include easing visa regulations to attract a greater number of visitors to South Africa and reducing barriers to entry for companies through the enforceability phase of the Competition Amendment Act.
However, Moody’s warns that the socioeconomic environment will delay and constrain the adoption and implementation of wider structural reforms that could significantly improve competitiveness.
While the government has yet to define its priorities under Ramaphosa's renewed mandate, labour market inefficiency and skills mismatches will be particularly hard to address, Moody’s adds.
South Africa ranked 121st out of 137 economies in health and primary education in the World Economic Forum's 2017 to 2018 Global Competitiveness Index and ninety-third in labor market efficiency, lagging behind most emerging markets.
Reforming labour markets and education faces significant opposition from unions
and other interest groups and, combined with the fact that such reforms by their nature take time to show results, Moody’s does not expect a significant acceleration in employment in the foreseeable future, which will continue to constrain the economy’s growth potential.
Additionally, over the last decade, slow growth and relatively large fiscal deficits increased South Africa’s government’s debt burden to 57% of GDP by the end of the 2018 fiscal year, and 63% if including State-owned utility Eskom’s guarantees.
“We now include Eskom's government-guaranteed debt as government debt in our assessment of South Africa's fiscal strength. The debt of other nonfinancial public sector entities represents another ten percentage points of GDP, though we do not yet include those liabilities in the government's debt ratio,” Moody’s notes.
In seeking to arrest the rise in indebtedness, the government will need to overcome spending pressures relating to interest and wages, together with obstacles to raising further revenues, including from the diminishment of the South African Revenue Services’ capacity under the Zuma administration.
Without policy measures that bring the deficit down from recent levels of between 4.5% and 5% of GDP, the debt-to-GDP ratio will likely rise above 70% (including Eskom guarantees) over the next few years, higher still in a downside scenario involving yet weaker growth, a wider fiscal deficit and tighter financing conditions.
Such a scenario will put further pressure on the sovereign's credit profile, particularly if accompanied by further support to Eskom or any other State-owned enterprise beyond the annual budgeted financial assistance worth R23-billion, equal to about 0.4% of fiscal year 2019 GDP, included in Moody’s deficit projections.
“We expect the country's fiscal profile to strengthen over time, with its deficit falling to 2.5% of GDP in fiscal year 2019 and further below in the outyear,” Moody’s says.
Although South Africa’s long-term growth outlook remains weak and its fiscal metrics are eroding, Moody’s believes South Africa's economy and debt composition provide a number of credit strengths that bolster the sovereign's resilience to shocks and support the Baa3 rating.
Signs that this resilience has diminished, making the sovereign more vulnerable to a sudden shift in financing conditions for instance, will, however, weaken the credit profile, it adds.
One source of resilience to shocks relates to economic diversification within South Africa, with a GDP of $368-billion in 2018, South Africa has a “well-developed financial
services sector which, combined with the real estate sector, accounted for 20% of nominal gross value-added (GVA) in 2018”.
Trade accounted for a further 15%, followed by manufacturing with 13%. The mining sector also remains sizeable, accounting for 8% of GVA in 2018.
The central bank’s adherence to its inflation and financial stability mandate supports effective macroeconomic policy. The fiscal framework is also strong, though its performance has been mixed.
Spending ceilings have been the main fiscal anchor and have rarely been loosened through successive budget exercises, but debt-to-GDP ratios, another policy anchor, have exceeded the targets presented in the budget over the last four years.
According to Moody’s, government liquidity risk in South Africa is well-managed and the maturity and currency structure of government debt limits its exposure to shocks, including external shocks.
This, Moody’s adds, is highlighted by adequate levels and continued accumulation of foreign-exchange reserves.
Although South Africa’s External Vulnerability Indicator (EVI), which measures external debt payments against foreign exchange reserves, exceeds 100%, it falls to 69% if adjusted to only reflect foreign-currency debt payments which represent a claim on reserves.
Adjusted, South Africa's EVI is in line with that of its peers.