Scope publishes South Africa first-time sovereign rating of BB+ with Stable Outlook
For the associated Rating Report, click here.
Scope Ratings GmbH (Scope) has today affirmed and published the Republic of South Africa’s long-term foreign- and local-currency issuer and senior unsecured ratings of BB+ with Stable Outlook. The rating agency has affirmed and published short-term issuer ratings of S-3 in local- and foreign-currency, with a Stable Outlook.
Summary and Outlook
South Africa’s BB+ foreign- and local-currency issuer ratings reflect: i) the size and diversification of the domestic economy – one of the largest of the African continent; ii) a favourable public-debt profile, including long average maturities and debt denominated predominantly in domestic currency, and strong market access; iii) a robust monetary policy framework; and iv) a resilient banking system and well-developed financial sector. The ratings also reflect South Africa’s weight in regional and international financial institutions and access to multilateral funding channels.
The sovereign’s credit ratings are challenged by credit weaknesses such as: i) modest economic growth potential, constrained by unsatisfactory energy infrastructure and high unemployment; ii) a rising government-debt burden given elevated expenditure as well as risk from contingent liabilities; and iii) socio-economic vulnerabilities such as elevated income inequality hindering structural reform and budgetary consolidation.
The Stable Outlook assigned represents Scope’s opinion that risks to the ratings are balanced over the next 12 to 18 months.
The ratings/Outlooks could be upgraded if, individually or collectively: i) sustained fiscal consolidation raises confidence for the public-debt ratio to be placed on a firm declining trajectory; ii) reforms addressing long-standing fundamental challenges enable a material rise of economic growth potential and countering of social-economic risk; and/or iii) external-sector risks are further redressed, such as bolstering of foreign-currency reserves.
Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) the public-debt burden deteriorates beyond present expectations due, as an example, to delays of budgetary consolidation and/or greater-than-anticipated support being required for state-owned enterprises (SOEs); ii) the external-sector risk profile weakens, such as decline of foreign-currency reserves and/or sharp depreciation of rand; and/or iii) the economic growth outlook significantly weakens beyond present expectations, exacerbating socio-developmental challenges.
South Africa’s BB+ ratings are firstly anchored by its large and well-diversified economy. South Africa has one of the largest economies (nominal GDP of around USD 411bn as of 2022) of the African continent after that of Nigeria and Egypt, and comparatively elevated GDP per capita (USD 6,750) compared with sub-Saharan Africa regional averages. Its diversified economy centres around robust tertiary (accounting for 70% of output) and manufacturing (13%) sectors, strengthening resilience against external shocks and mitigating degree of exposure to commodity boom-bust price cycles. Furthermore, South Africa’s economic importance also translates into substantive political clout in the region and globally. South Africa is the only African member state of the G-20, supporting regional and international policy leadership and influence, for instance around addressing regionally-crucial development themes such as illicit financial flows and infrastructure financing. South Africa benefits from access to multilateral financing from African and other international financial institutions, such as USD 4.3bn via a Rapid Financing Instrument financing programme from the International Monetary Fund during Covid-19 crisis peaks.
Secondly, the BB+ ratings are anchored via a comparatively favourable debt profile and strong market access of the government. Public debt is mostly fixed-rate (74% of domestic bonds), denominated predominantly in rand (around 90%) and with long average maturity (of 12 years)1. Short-term treasury bills reflected only 11% of the aggregate domestic debt stock as of August 2022.2 This sound public-debt structure curtails interest-rate, forex and debt roll-over risks amid global monetary tightening and rand volatility. Furthermore, the government debt last year was lower than previously anticipated after rebasing of national accounts elevated the level of GDP.
The national fiscal framework anchors debt sustainability such as nominal primary expenditure ceilings, which are announced three years ahead, a robust debt and cash management strategy: in August, National Treasury held ZAR 310bn (4.8% of GDP) via cash, and strong data reporting and financial transparency, such as surrounding the contingent liabilities of public enterprises. The adoption of a debt-ceiling rule to complement an existing nominal expenditure ceiling would furthermore be credit positive. Next, deep domestic capital markets present government with access to a diversified group of investors, such as pension funds and insurers, as well as to issuance across a range of maturities and instruments, including of inflation-linked debt (which accounts for approximately 22% of domestic debt outstanding). This enables South Africa to fund a bulk of annual gross borrowing requirements via domestic markets and limit dependency on fragile international investor sentiment.
The third factor underscoring South Africa’s BB+ credit ratings is a robust monetary policy framework. The South African Reserve Bank (SARB) holds an enviable repute in international debt capital markets aided via sound independence from the national government, a proven track record of management of inflation, and sophistication and efficacy of monetary policy execution, as demonstrated during Covid-19 crisis peaks via the swift introduction of unprecedented bond purchases in preservation of financial stability. SARB as well relies upon a large and well-regulated domestic banking system acting as an effective conduit for monetary policy to the real economy, especially crucial in view of hindrances to the monetary transmission from a system of wage bargaining and strength of trade unions. Inflation edged slightly lesser to 7.5% in September, but is expected by SARB to stay above a 3-6% target range until Q2 2023 (averaging 6.5% in 2022 before 5.3% in 2023) and reach a midpoint of said target range only by end-2024. SARB has raised rates six times since November 2021, most recently 75bps to 6.25% last month3. Scope expects the central bank to hike policy rates further to 7% by end-2022, and 7.5% in 2023. Plans to trim the central-bank inflation target range are likely to be postponed until inflation eases significantly.
Finally, South Africa’s BB+ rating reflects its resilient banking system and financial industry. Banking-system fundamentals are sound as reflected via adequate system-wide tier-1 ratios (of 14.9% of risk-weighted assets as of August 2022) and strengthened profitability. Sound banking-system fundamentals raise resilience to some degree of deterioration in asset quality amid rising rates. Non-performing loans rose to a still moderate 4.7% of gross loans in August. The sound financial system is supported by regulatory oversight of SARB with a domestic financial framework in line with Basel-III requirements. Nevertheless, the economy faces regulatory weaknesses in its money laundering oversight. Deep domestic financial markets grant banks access to meaningful liquidity – and similarly reduce dependency on foreign-currency financing – curtailing exposure to large-scale refinancing risk.
The external sector of South Africa has been strengthened but remains a vulnerability during global crises and phases of emerging-market capital outflow. Net international investment assets amounted to a robust 16% of GDP as of Q2 2022. Pre-pandemic current-account deficits were predominantly financed via substantive portfolio equity and debt investment. External debt stood at only 40% of GDP as of Q2 2022 with only around half of this in foreign currency. Furthermore, above 80% of outstanding external debt is long-term. Next, the floating exchange rate enables rand depreciation to act as shock absorber during crises and limit drawdown of official reserves. Foreign-exchange reserves (of USD 46.2bn as of August 2022) cover, however, only a moderate 64% of short-term foreign debt (on a residual-maturity basis), stronger compared with Covid-19 crisis lows of 46% coverage late last year but weaker compared with the above 100% of the early 2010s. The central bank has constructively held a long-running policy of refraining from exchange-rate interventions. There was a second consecutive year of a current-account surplus (of 3.7% of GDP) last year. However, rise of fuel prices will result in smaller current-account surpluses of 1% of GDP in 2022, before correction in export commodity prices and higher imports return the current account to an annual deficit by 2023. Government foreign-currency debt is low, but elevated participation of non-residents in the local-currency government debt market (holding 26.8% of outstanding domestic securities as of September) represents a risk. Rand is 12% weaker against dollar since the start of the year, although this has been predominantly a dollar phenomenon – and the nominal effective exchange rate of rand is largely unchanged this year.
South Africa’s credit ratings are challenged by relevant credit weaknesses.
Firstly, South Africa’s long-run growth potential is significantly restricted by long-standing energy (with record power outages) and infrastructure (especially in rail) bottlenecks and labour-market rigidity. Following a post Covid-19 crisis rebound (4.9% growth in 2021), Scope expects economic growth to ease to 1.8% in 2022 and 1.1% for 2023 – next year falling below the potential rate estimated around (just) 1.5% a year. This moderate growth potential prevails despite annual working-age population changes of 1.5% a year anticipated over 2022-27. Growth remains anchored by the economic re-openings from Covid-19, but this impetus fades as the international environment furthermore has become more challenging.4 Weak investment expenditure and an inflexible labour market weigh on the economy. An inefficient energy infrastructure is left unaddressed partly due to high debt liabilities (8% of GDP) of national utilities supplier Eskom. The economic reform agenda begun in October 2020 (Operation Vulindlela) is seen as the most ambitious and integrated programme to date for addressing outstanding credit challenges, although implementation has been delayed by several financing and regulatory hurdles.
Secondly, sustained large budget deficits have represented a challenge. Scope expects a consolidated budget deficit of 4.75% of GDP for FY2022/23 (better than an earlier government objective of 6% of GDP) followed by 5.2% for FY2023/24 – aligned with government targets of reaching a primary balance in the next fiscal year. This comes after a 5.3% of GDP deficit of FY2021/22, down from a 10% deficit in FY20/21 – thanks to higher-than-anticipated revenue collections. In the recent Medium-Term Budget Policy Statement (MTBPS)5, the government deferred a decision around permanent income support for the most vulnerable by one year but approved another extension by a year until end-March 2024 of the Covid-19 Social Relief of Distress (SRD) grant. In Budget 2022, the government approved ZAR 5.2bn of tax relief in support of economic recovery, to provide respite from fuel-tax rises and to boost incentives for youth employment.6 Spending on compensation furthermore rises 4.1% in nominal terms during FY2022/23, reflecting a 3% pensionable wage rise. Spending rises and non-observation of nominal expenditure ceilings since FY2018/19 represent a core credit weakness – undermining dependability of the fiscal framework. Risks to the budgetary outlook include: i) renewed economic recession bringing lesser tax revenue and curtailed spending discipline; ii) settlement for higher wage hikes in view of elevated inflation; iii) a further extension or permanent inclusion of the SRD grant – which the government believes absent a permanent source of funding could impair sustainability of public finances; iv) greater-than-anticipated aid for struggling SOEs; and/or v) higher-than-anticipated borrowing costs (especially after outstanding inflation-linked domestic debt is accounted for).
Sustained deficits have translated to a steady rise of the public-debt burden, which is elevated by emerging-market standards. New GDP data announced August 2021 concluded the economy was 11% larger than earlier estimated.7 This contributed to statistically trimming debt-to-GDP to 69% by end-2021, as compared with a pre-revision IMF debt-to-GDP forecast of 81% by year-end 2021 (and nearing 100% by 2026). However, although the data revision lowered the debt-to-GDP ratio meaningfully – it does not fundamentally change the trajectory, and Scope expects government debt to rise to 73.5% of GDP by 2024, before continuing to rise medium run. Hence, a government expectation under the MTBPS5 of a peak of the public-debt ratio at 71.4% by the current fiscal year – two years earlier and nearly four percentage points lower than the government had previously estimated – is subject to risk, especially ahead of 2024 general elections. Net interest payments will average around 18% of government revenue over the next two years, before rising to over 20% by 2024. Net interest payments amounted to 8% of government revenue as of 2008.
Inflationary pressure furthermore weighs upon financial circumstances of municipalities with hardship cumulating taxes from households, posing adverse consequences for provision of public services and for SOEs such as Eskom (with around USD 3bn owed to it by municipalities as of end-July). Contingent liabilities, mostly tied to guarantees on debt of non-financial public enterprises (9.8% of GDP, of which 6.2% of GDP is for Eskom), financial public enterprises (1.9% of GDP) and independent power producers (2.8% of GDP) are not exceptionally high, but balance-sheet weaknesses of multiple SOEs (such as in electricity and transport sectors) underscore risk of further crystallisation of liabilities to the government balance sheet. The government expects to transition one third to two thirds of Eskom loan obligations to the state balance sheet. Under the MTBPS, three SOEs (roads agency SANRAL, infrastructure operator Transnet and arms manufacturer Denel) receive further financial aid of an aggregate ZAR 30bn, with ZAR 5bn remaining under a contingency reserve for government-owned Land Bank.
Finally, substantive socio-economic risks are a challenge for the rating. High income inequality, 40% of the population under the lower national poverty line and an elevated unemployment rate (33.9% as of Q2 2022), with furthermore youth unemployment of a high 61%, reflect challenges to higher potential output and fiscal sustainability. Shortcomings of education and professional-training systems exacerbate post-Apartheid divides, illustrated via a broad-based Black Economic Empowerment programme and controversial land redistribution agendas absent compensation. Weaker delivery of basic services propels structurally elevated demand for social spending. Socio-economic conditions furthermore affect political and institutional stability, as displayed in July 2021 riots over the imprisonment of former president Jacob Zuma. The African National Congress (ANC)’s electoral results weakened during 2021 municipal elections, and there is risk of ANC not receiving an outright majority during 2024 general elections. Reports of state capture during administration of ex-president Zuma spoke to vulnerability of South African institutions to corruption, although the current government has made progress in addressing this. The incumbent administration of President Cyril Ramaphosa and courts have sought to strengthen institutions, although this has been encumbered by graft scandals.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘bb+’ for South Africa. South Africa receives no adjustment to this indicative rating via the reserve-currency adjustment under the sovereign rating methodology. As such, under the methodology, ‘bb+’ final indicative ratings can be adjusted by the Qualitative Scorecard (QS) by up to three notches, depending on the size of relative credit strengths or weaknesses versus CVS-indicative peers based on analysts’ qualitative analysis.
For South Africa, the following relative credit strengths are identified under the QS: ‘monetary policy framework’; ‘debt profile and market access’; ‘external debt structure’; ‘banking sector performance’; and ‘banking sector oversight’. Conversely, ‘growth potential of the economy’; ‘fiscal policy framework’; ‘debt sustainability’; ‘environmental risks’; and ‘social risks’ are identified via the QS as credit weaknesses as compared against indicative sovereign peers.
The combined relative credit strengths and weaknesses under the QS generate no net adjustment and signal ‘BB+’ sovereign credit ratings for the Republic of South Africa.
The results have been discussed and confirmed by a rating committee.
Factoring of Environment, Social and Governance (ESG)
Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 25% weighting under the methodology’s quantitative model (CVS).
On environmental risk, South Africa scores weakly under the CVS due to high carbon-emissions intensity. However, it scores strongly on vulnerabilities to natural disasters when compared with other African sovereign states. The ecological footprint of consumption relative to South Africa’s available biocapacity is displayed as being in line with that of an international median. The complementary qualitative QS assessment of ‘environmental risks’ is evaluated as ‘weak’ against bb+ model-indicative sovereigns, in view of challenges in transition to a decarbonised energy architecture, also given significant effects for core mining and manufacturing sectors of said transition. Reducing heavy reliance upon coal (which accounts for 70% of energy and some 85% of electricity), diversifying the mix of energy sources, and investing in renewables represent priorities. South Africa signed an agreement with international donors during COP26 in November of 2021 to receive USD 8.5bn of loans, grants, guarantee schemes and direct private investment for coal phase-out and de-carbonisation, although details of said package remain under discussion. Rehabilitation of domestic electricity production capacity, such as extension of life of the Koeberg nuclear power station, coupled with raising of supply via renewable energies, through the Independent Power Producer Programme, require multi-billion-rand investment to offset lost capacity from decommission of ageing infrastructure (35 years of age on average). The debt overhang of Eskom, and the state-owned enterprise’s “unbundling”, could furthermore delay progress on net-zero. Still, near-term supply constraints could be somewhat eased should private companies be allowed to self-generate up to 100MW absent licenses. Recent floods in KwaZulu-Natal damaged infrastructure, presented budgetary costs and disrupted trade operations at port city of Durban.
For social-risk factors captured via the quantitative CVS model, South Africa holds a comparatively strong old-age dependency ratio due to young demographics – similar to other societies of the Africa continent. However, South Africa scores poorly on the CVS on labour-force participation and level of income inequality (the latter as captured via the ratio of the income share of the 20% of persons with the highest household incomes to the 20% of persons with lowest household incomes). A complementary QS assessment of those ‘social risks’ not captured by the CVS Scope concludes as being ‘weak’ as compared with the profiles of indicative sovereign peers. A programme of Broad-Based Black Economic Empowerment alongside controversial reforms of land redistribution absent compensation have been advanced. There have been recent periods of xenophobic violence. Socio-economic vulnerabilities reflect elevated poverty and an unequal wealth distribution. Furthermore, South Africa performs comparatively weakly along healthy life expectancy (117th of 141 countries) and skills of the current workforce (101st of 141) categories according to the Global Competitiveness Index of the World Economic Forum8. However, favourable growth of the working-age population (of an estimated 1.5% a year between 2022-2027, easing slightly from 1.6% during the previous decade) raises potential output growth, even if this furthermore drives an employment crisis. South Africa’s reconstruction and recovery programme, aiming to address challenges such as high unemployment, poverty and income inequality, energy and water crises, and inadequate infrastructure and logistics bottlenecks, could favour a more favourable assessment of social-risk factors over the future.
Under governance-related factors captured under the CVS, South Africa scores below average on a composite index of six World Bank Worldwide Governance Indicators, although nevertheless stronger than average performance of sub-Saharan African peer nations. Furthermore, Scope evaluates governance via an ‘institutional and political risks’ analytical category in the complementary QS analyst assessment. In the QS, constitutional checks and balances and relative political stability are balanced by prevailing governance challenges with an aggregate assessment of ‘neutral’ against the risk profiles of ‘bb+’ indicative sovereign peers. As unrest last July (one of the most violent since an end of Apartheid) demonstrated, South Africa is vulnerable to civil instability with implications for business operating conditions. The ANC’s electoral results weakened in 2021 municipal elections, but the party is seen remaining the dominant political grouping after 2024 general elections. Details of state capture under ex-President Zuma were highlighted by the Zondo Commission. Implementation of said Commission's core recommendations will prove challenging, but their acceleration could enhance perceptions around the control of corruption and boost business sentiment.
The main points discussed by the rating committee were: i) fiscal policy; ii) debt sustainability; iii) reserves and the external sector; and iv) peers considerations.
Rating driver references
1. South Africa 2021 Article IV Consultation – IMF
2. Market Data and Information – National Treasury of the Republic of South Africa
3. Statement of the Monetary Policy Committee September 2022 – South African Reserve Bank
4. Economic Surveys: South Africa August 2022 – OECD
5. 2022 MTBPS: Medium Term Budget Policy Statement – National Treasury
6. Budget Review 2022 – National Treasury
7. A new and improved GDP is here! – Statistics South Africa
8. The Global Competitiveness Report 2019 – World Economic Forum
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (CVS model version 2.1), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.
Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation NO
With Access to Internal Documents NO
With Access to Management NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks is/are UK-endorsed.
Lead analyst: Dennis Shen, Director
Person responsible for approval of the Credit Ratings: Dr. Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on14 October 2022.
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.
Conditions of use / exclusion of liability
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