Saturday, June 04, 2016

South Africa Avoids Feared Downgrade to Junk Status
Krista Mahr in Johannesburg
Financial Times

South Africa avoided a feared downgrade to its credit rating to junk status on Friday, in a reprieve to officials who have been scrambling to restore confidence in one of the world’s most traded emerging markets.

Standard & Poor’s affirmed South Africa’s foreign currency bond rating on Friday evening at one notch above subinvestment grade, or “junk” status. The rating agency cited improvements in the energy sector, pending labour and mining reforms, and the government’s resolve to reduce fiscal deficits at a faster-than-expected pace.
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S&P, however, maintained its negative outlook, noting low gross domestic product growth and rising political tensions, and warning that it could lower its ratings this year or next “if policy measures do not turn the economy around”.

A ratings downgrade, which could raise borrowing costs, has loomed over Africa’s most industrialised nation all year.

Government officials and business leaders have been working to boost confidence in the economy since President Jacob Zuma sacked a well-respected finance minister in December and replaced him with a little known backbencher, sending the rand plummeting. The drive has been led by Pravin Gordhan, the finance minister brought in after the tumult.

The government welcomed the S&P decision. “It’s a very rewarding signal,” Mr Gordhan told the Financial Times after the announcement. He said it will encourage the parties that have been working together “to work even harder with a common sense of purpose.”

Responding to the fact that S&P highlighted political tensions in its statement, Mr Gordhan said ratings agencies were focusing on politics in several countries, not just South Africa. “We have our own political dynamics in South Africa, and these will be increasingly noisy until the local government elections,” Mr Gordhan said.

“It’s a reprieve, certainly,” said David Faulkner, economist at HSBC Africa, who said it gave time to see if growth measures set in motion this year, including improvements in the energy, mining and tourism sectors, would have an effect.

But he added: “To durably remove the risk of a downgrade, you need more aggressive structural reforms that significantly raise the country’s growth potential.”

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South Africa’s rand strengthened to a three-week high on Friday, to 15.14 per dollar.

Yet international investors remain wary of South Africa’s dysfunctional economic and political environment. Foreign portfolio inflows have been volatile and equity funds in South Africa suffered larger outflows than any other emerging market in late May.

But international investors have been net buyers of the country’s bonds in the past week, helping to send the yield on benchmark 10-year government bonds, denominated in rand, to a three-week low of 9.19 per cent on Friday.

While the S&P decision gives politicians and business leaders time, some doubt whether they will be able to turn things around quickly enough to avoid a downgrade later this year. The economy is forecast to grow 0.6 per cent in 2016.

The political backdrop is also fraught, with the governing African National Congress facing a tough fight in August municipal elections with an energised opposition and increasingly pessimistic voters. Two courts have also ruled against Mr Zuma in recent months and talk has intensified of a power struggle with Mr Gordhan.

It’s a reprieve, certainly. But to durably remove the risk of a downgrade you need more aggressive structural reforms

- David Faulkner, economist at HSBC Africa

Peter Attard Montalto, senior economist at Nomura International, said last week that South Africa was on an “almost inevitable” path to junk status without a big enough crisis to jolt it into gear, owing to an economy held back by uncertainty, murky policies and frequent mistakes. “It is very, very easy to get off this path, but not in the current environment in South Africa,” he said.

Countries downgraded to subinvestment status can take up to a decade to return to investment grade, said Nazmeera Moola, co-head of SA fixed income at Investec Asset Management, although some recover more quickly if their governments use the event as a catalyst to meaningfully change course.

“Right now there’s more focus on political infighting,” said Ms Moola. “South Africa has built up a lot of credibility over a long period and it’s eroding. It’s about the direction of travel, and right now it’s the wrong direction.”

Additional reporting by Elaine Moore in London

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