Markets digest credit ratings downgrades in South Africa

Text size +-
Share

Rising uncertainty over fiscal policy has seen South Africa’s sovereign credit cut to junk status by two rating agencies, although the move appears to have had only a modest impact on the currency thus far, with inflation still within the target range.

Following a Cabinet reshuffle at the end of March that saw President Jacob Zuma replace the minister of finance Pravin Gordhan with Malusi Gigaba, ratings agency Fitch announced earlier this month it was downgrading South Africa’s long-term issuer default ratings (IDRs) – for both foreign and local currency – from “BBB-” to “BB+”, which are considered below investment grade.

As widely anticipated by the markets, the downgrade saw the rand soften against most major currencies, while the banking index for the Johannesburg Stock Exchange fell by 13.6% between March 27 and April 7.

The Fitch downgrade came just four days after a second major agency, Standard & Poor’s (S&P), also cut the country’s sovereign rating to junk status, citing the impact of the reshuffle and concerns over delays to much-needed fiscal reforms.

“We think that ongoing tensions and the potential for further event risk could weigh on investor confidence and exchange rates, and potentially drive increases in real interest rates,” S&P said.

Meanwhile, a third ratings agency, Moody’s, has placed South Africa on notice, announcing at the start of April that it would conduct a review ahead of a potential downgrade, though it would not make a decision for up to 90 days.

Banks under the microscope

The weaker economic outlook and increased borrowing costs resulting from the downgrades have had an impact on the country’s biggest banks, many of whom are exposed to state-owned enterprise and government debt.

Although the country’s lenders have healthy indicators, with low levels of non-performing loans and a diversified geographic portfolio, Fitch announced in early April it was downgrading the long-term IDRs of Absa Bank, FirstRand Bank, Investec, Nedbank and Standard Bank from “BBB-” to “BB+”. The move tracked a similar decision by S&P a few days earlier.

“The deterioration in sovereign creditworthiness brings increased risks to the banking sector,” Fitch noted. “Higher borrowing costs for the sovereign will translate into further pressure on economic growth.”

While South Africa’s commercial interest rates are currently among the lowest on the continent, the ratings cuts may lead to a slowdown in private sector credit, given that the downgrades will lead to higher borrowing costs for the lenders, which in turn are likely be passed on to clients.

Currency holds after initial drops

However, while the downgrades will likely slow borrowing activity, the broader impact on other key indicators appears to have been relatively modest. A Reuters poll conducted in early April, for example, found many financial analysts see a smoother path forward for the rand, predicting it will remain stable for the rest of the year.

The poll suggested that, following the currency’s decline in the run-up to the Cabinet reshuffle and its 7% drop after Gordhan’s dismissal, markets had already priced in the impact of the upheaval and ratings downgrades.

The data appear to bear this out: despite its fall in early April, the rand is still trading well above its 2016 levels against the US dollar and has stayed flat into the second quarter, not yet reversing gains seen last year. This stability, if maintained, should help ease concerns over any further inflationary impact from the ratings downgrade.

With the effects of ratings cuts tapering and the rand steady so far this year, no major hike in import costs is expected if the currency does not experience significant additional depreciation.

The South African Reserve Bank has warned the downgrade could increase pressure on the rand and drive capital outflows, but has not revised its year-end outlook for inflation. According to Statistics South Africa, inflation dropped to a six-month low of 6.1% in March, down from 6.3% the previous month.

On April 10, however, the central bank issued a statement saying any further weakening of the exchange rate would put its 6% inflation target at risk.

Should the rand hold steady through 2017, it would help curb the recent decline in investor and business confidence – though, to boost sentiment meaningfully, the country will likely need more than a steady currency.

Share

Covid-19 Economic Impact Assessments

Stay updated on how some of the world’s most promising markets are being affected by the Covid-19 pandemic, and what actions governments and private businesses are taking to mitigate challenges and ensure their long-term growth story continues.

Register now and also receive a complimentary 2-month licence to the OBG Research Terminal.

Register Here×

Product successfully added to shopping cart

Read Next:

In South Africa

South Africa sets out to deepen ICT skills

The government is in the final stages of its review on the ICT sector in South Africa after the publication of a discussion paper in November, prior to the launch of a set of policy...

In Economy

Salem Yousef Al Qaseer, Chairman, Labour Standards Development...

What steps and measures has the LSDA put in place to limit the spread of Covid-19 and mitigate its social and economic impact?

Latest

Industry and Manufacturing: Year in Review 2020

– Supply chain disruptions severely slowed global industrial production

– Many companies successfully repurposed operations to meet Covid-19 needs

– Pandemic response looks set to...