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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of South Africa’s BB+ long-term foreign- and local-currency issuer and senior unsecured ratings and revised the Outlook to Negative, from Stable. The rating agency has furthermore affirmed South Africa’s S-3 short-term issuer ratings in local- and foreign-currency, maintaining a Stable Outlook.

Summary and Outlook

The revision of the Outlook for South Africa’s credit ratings to Negative, from Stable, reflects the pursuant two credit rating drivers:

1. A rising government-debt burden given elevated primary expenditure, growing interest costs as well as crystallisation of contingent liabilities – underlined in the recent debt-relief operation undertaken for Eskom; and

2. A weakening of the economic growth outlook, under constraints of only modest economic growth potential, constrained by inadequate energy infrastructure and elevated unemployment.

Governance challenges and socio-economic vulnerabilities such as elevated income inequality hindering structural reform and budgetary consolidation are further credit weaknesses.

Nevertheless, the affirmation of South Africa’s BB+ long-term issuer ratings reflects multiple credit strengths such as: i) the size and diversification of the domestic economy – the second largest of the African continent; ii) a favourable public-debt profile, including long average maturities and debt denominated predominantly in domestic currency; iii) a robust monetary policy framework; and iv) a resilient banking system, an advanced financial sector and deep capital markets. The ratings also consider South Africa’s weight in regional and international financial institutions and access to multilateral funding channels.

The Negative Outlook assigned represents Scope’s opinion that risks to the long-term ratings are skewed to the downside during the next 12 to 18 months.

The ratings/Outlooks could be downgraded if, individually or collectively: i) the public-debt burden continues to rise due, as an example, to delays in budgetary consolidation, a growing interest burden and/or additional support being needed for state-owned enterprises (SOEs); ii) the economic growth outlook stays impaired, exacerbating socio-developmental challenges; iii) the external-sector risk profile weakens, such as a decline in foreign-currency reserves and/or additional depreciation in the rand; and/or iv) governance challenges were to escalate.

Conversely, the long-term Outlooks could be revised back to Stable if, individually or collectively: i) sustained fiscal consolidation raises confidence that the public-debt ratio will be stabilised medium run; ii) reforms addressing long-standing fundamental challenges enable a material rise in economic growth potential and countering of social-economic risks; and/or iii) external-sector risks are further redressed, such as a significant bolstering of foreign-currency reserve stocks.

Rating rationale

The first driver of the Outlook change reflects a rising government-debt burden given elevated primary expenditure, growing interest payments as well as crystallisation of contingent liabilities.

There has been a rise of the public-debt burden, which is elevated by emerging-market standards. Scope has historically assumed a rising trajectory of South African debt as being baseline. Under its debt sustainability analysis, the agency sees government debt picking up to 76.1% of GDP by 2025 and 87.5% of GDP by 2028, from 56% in 2019 and 24% at 2008 lows. Under a downside economic scenario, government debt might approach 100% of GDP by 2028. Hence, a government expectation under its 2023 Budget Review¹ for a peak of the public-debt ratio at a level of nearly 74% by fiscal year 2025/26 seems optimistic. The government had previously forecast, under the 2022 Medium Term Budget Policy Statement (MTBPS)², debt-to-GDP to peak at 71% by fiscal year 2022/23.

As importantly, net interest payments are a growing burden on the national budget – accounting for around 18% of general government revenue during this calendar year, before rising to nearly 28% by 2028 under a baseline scenario. Net interest payments accounted for (just) 8% of government revenue as of 2008. Referenced figures are meaningful particularly when compared against that of other bb-rated sovereign issuers: namely, Georgia (net interest payments of 4% of revenue as of 2023, same ratio by 2027), Serbia (5% in 2023, same by 2027), and Greece (7% in 2023, 9% by 2027).

10-year treasury yields stand around 10% – a rise from the 8.5% in early 2022. Driven by higher financing costs, annual gross government financing requirements are seen rising from 15.3% of GDP in 2023 to about 20.3% by 2028. For emerging-market issuers, government financing requirements of above 15% are considered by the IMF as a level representing more restricted fiscal space.

National Treasury’s debt-relief operation for Eskom³, the state-owned electricity utility, sees the government prudently assume about 60% of Eskom’s debt of ZAR 423bn – settling ZAR 184bn Eskom owes over the next three years via a loan converting to equity conditional on performance benchmarks before taking on a further ZAR 70bn of debt directly by FY2025/26. The potential acquisition of some 60% of the debt is near the upper end of a one- to two-third range outlined last year and equivalent to about 3.4% of GDP of debt for the national government. On the whole, the South African government’s contingent liabilities are not exceptionally high, but balance-sheet weaknesses of some SOEs (such as in the electricity and transport sectors) speak to possibility for further crystallisation of liabilities to the government balance sheet. Under the 2022 MTBPS, three SOEs (roads agency SANRAL, infrastructure operator Transnet and arms manufacturer Denel) received further financial aid of an aggregate ZAR 30bn, with ZAR 5bn remaining under a contingency reserve for government-owned Land Bank.

The general government deficit declined to about 4.5% of GDP in FY2022/23 – roughly equal to Scope’s expectations (of 4.75% for FY2022/23) as the budget outperformed earlier government objectives. Nevertheless, we see said deficit re-rising to 5.5% for FY2023/24 ahead of the coming elections before averaging 7% between fiscal years 2024/25 and 2028/29. This assumption for meaningful deficits medium run is comparatively pessimistic compared to government projections for the consolidated budget deficit to conversely narrow from 4% of GDP during FY2023/24 to 3.2% by FY2025/26. The government’s assumption for preservation of primary fiscal surpluses from FY2022/23 through the remainder of the forecast horizon, reaching a primary surplus of 1.7% of GDP by FY2025/26, appears optimistic considering a record of (modest) primary deficits during the decade before Covid-19.

In last year’s MTBPS², the government deferred a decision surrounding permanent income support for the most vulnerable by one year but approved a further extension by a year until end-March 2024 concerning the Covid-19 Social Relief of Distress (SRD) grant. Spending rises and non-observation of nominal expenditure ceilings since FY2018/19 are a credit weakness – calling into question dependability of the fiscal framework. Risks to the budget 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 thinks absent a permanent source of funding might impair the sustainability of public finances; iv) greater-than-anticipated aid for struggling SOEs; and/or v) higher-than-anticipated borrowing costs (especially given outstanding inflation-linked domestic debt).

The second driver of this Outlook change is a weakening of the economic growth outlook, under constraints of modest economic growth potential, and constrained by unsatisfactory energy infrastructure and elevated unemployment.

After a post Covid-19 crisis economic rebound (4.9% growth in 2021 and 2.0% in 2022), Scope expects economic growth to ease to 0.8% this year – falling below its potential rate estimated around (a modest) 1.5% a year. This is before moderate rebound to 1.8% growth next year. South Africa’s growth is held back by persistent energy (record power outages) and infrastructure (especially in rail) bottlenecks alongside labour-market rigidities. This moderate output growth potential prevails despite annual working-age population changes of 1.5% a year estimated by the OECD during 2023-28. Weak investment expenditure and an inflexible labour market weigh on the economy. Unemployment was 33% of the active labour force as of end-2022 and is seen remaining around similar levels during 2023-24. Youth unemployment stands at an elevated 61%. The economic reform agenda begun in October 2020 (Operation Vulindlela) is seen as the most ambitious and integrated programme to date for addressing credit challenges. As of Q3 2022, nearly 50% of reform milestones are either completed or on track.

In addition, governance challenges are considered in the ratings. The African National Congress (ANC)’s electoral results weakened during 2021 municipal elections, and there is potential of ANC needing to rule in coalition following 2024 general elections – presenting greater policy uncertainties. Reports of state capture during the administration of ex-president Jacob Zuma were reemphasised in a decision from the Financial Action Task Force (FATF) to list South Africa as a “jurisdiction under increased monitoring”⁴. The incumbent administration of President Cyril Ramaphosa and courts have sought to strengthen public-sector institutions against allegations of corruption and fraud, although this has been encumbered by graft scandals. National Treasury’s decision earlier this month to lift some disclosure requirements and move the disclosure of irregular, fruitless and wasteful expenditure instead to Eskom’s annual report for three years⁵ – before promptly withdrawing this exemption upon critique – underscores underlying governance risks. South Africa’s scores on the World Bank Worldwide Governance Indicators have declined during the last decade.

The external sector has been strengthened but remains a vulnerability during global crises and phases of emerging-market capital outflows. Net international investment assets amounted to a robust 17% of GDP as of Q4 2022. Pre-pandemic current-account deficits were predominantly financed by substantive portfolio equity and debt investment. External debt stood at only 39% of GDP as of Q4 2022 with only around half of this in foreign currency. Furthermore, nearly 80% of outstanding external debt is long-term. Furthermore, the floating exchange rate enables rand depreciation to act as a shock absorber during crises and limit the drawdown of official reserves. Foreign-exchange reserves (of USD 47bn as of February 2023) cover, however, only a moderate 87% of short-term foreign debt (on a residual-maturity basis), stronger compared with the lows of 54% coverage as of early last year but weaker compared against the above 100% levels of the early 2010s.

The central bank has constructively held a long-running policy of refraining from exchange-rate interventions. However, South Africa returned to a current-account deficit (of 0.5% of GDP) last year, underperforming Scope’s expectations for a modest surplus, after two consecutive years of such surpluses. The IMF sees the current account staying in a deficit of about 2-3% of GDP between 2023-28. Government foreign-currency debt is low, but elevated participation of non-residents in the local-currency government debt market (holding 25.2% of outstanding domestic securities in March) remains a risk – despite recent exits of foreign investors⁶. The nominal effective exchange rate is 8% weaker since the start of the year.

The affirmation of South Africa’s BB+ ratings reflects multiple credit strengths.

Firstly, the ratings are supported by the country’s large and well-diversified economy. South Africa has the second-largest economy (nominal GDP of around USD 399bn as of 2023) of the African continent after that of Nigeria, and comparatively elevated GDP per capita (USD 6,485) compared with sub-Saharan Africa regional averages. Its diversified economy centres around robust tertiary (accounting for 67% of value added) and manufacturing (16%) sectors, strengthening economic resilience against external shocks and mitigating the degree of exposure to commodity boom-bust price cycles. Furthermore, South Africa’s economic importance translates to 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, exemplified in the USD 4.3bn Rapid Financing Instrument from the International Monetary Fund during Covid-19 crisis peaks.

Secondly, the BB+ ratings are anchored by a comparatively favourable debt profile and strong market access. Public debt is mostly fixed-rate (accounting for 73% of domestic bonds), denominated in rand (around 87% of the debt stock) and with long average maturity (of 12 years)⁷. Short-term treasury bills represented only 10% of the domestic debt stock as of March 2023.⁸ 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 ratio was revised down in 2021 after the rebasing of national accounts elevated the level of GDP.

The national fiscal framework anchors debt sustainability via nominal primary expenditure ceilings, which are announced three years in advance, a robust debt and cash management strategy: in March, National Treasury held ZAR 249bn (3.5% of GDP) in cash, and strong data reporting and financial transparency, such as surrounding the contingent liabilities of public enterprises. Scope Ratings would consider the adoption of a debt-ceiling rule complementing the existing nominal expenditure ceiling as being credit positive. Furthermore, deep domestic capital markets present the 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 inflation-linked debt (which accounts for about 26% of domestic bonds outstanding). This enables South Africa to fund a bulk of its gross borrowing requirements via its domestic markets and limit dependencies on fragile international investor sentiment.

The third factor underscoring BB+ credit ratings is a robust monetary policy framework. The South African Reserve Bank (SARB) holds an enviable standing in international debt capital markets aided by sound independence from the national government, a proven track record in the management of inflation, and sophistication and efficacy of monetary policy execution, as demonstrated during Covid-19 crisis peaks vis-à-vis swift introduction of unprecedented bond purchases for preserving financial stability. SARB as well relies on 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 monetary transmission from a system of wage bargaining and given the strength of trade unions. Inflation edged slightly higher to 7.1% in March, and Scope expects headline inflation to average 6.1% in 2023 before 5.0% by 2024. Core inflation edged up to 5.2% in March – the highest level since February 2017. In March, SARB appropriately raised rates a further 50bps to 7.75%⁹. The central bank is expected to hike policy rates to 8.25% by end-2023, before cutting rates to 7.25% by end-2024. Plans to trim the central-bank inflation target range are likely to be postponed until inflation eases significantly.

Finally, the BB+ ratings of South Africa reflects a resilient banking system and financial industry. Banking-system fundamentals are sound as reflected in adequate system-wide tier-1 ratios (of 15.1% of risk-weighted assets as of February 2023). Sound banking-system fundamentals raise the system’s resilience to a degree of deterioration in asset quality amid rising rates. Non-performing loans rose to a still low 4.8% of gross loans by February. The sound financial system is supported by the 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, however – and similarly reduce dependency on foreign-currency financing – curtailing exposure to large-scale refinancing risks.

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 from 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 via the QS: ‘monetary policy framework’; ‘debt profile and market access’; ‘external debt structure’; ‘banking sector performance’; ‘banking sector oversight’; and ‘financial imbalances’. Conversely, ‘growth potential of the economy’; ‘fiscal policy framework’; ‘debt sustainability’; and ‘social risks’ are identified in the QS as being credit weaknesses based on a comparison with indicative sovereign peers.

The combined relative credit strengths and weaknesses under the QS generate a one-notch net upside 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 risks, South Africa scores weakly in the CVS due to high carbon-emissions intensity. It furthermore scores weakly on the vulnerability to natural disasters. 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 risk’ is evaluated as ‘neutral’ against bb model-indicative sovereigns, in view of challenges in the transition to a decarbonised energy architecture, also given significant effects for core mining and manufacturing sectors of said transition. Reducing heavy reliance on coal (which accounts for 70% of energy and some 85% of electricity), diversifying the mix of energy sources, and investing in renewables are 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 this package remain under discussion. Rehabilitation of domestic electricity production capacity, such as extension of the 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 the 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 eased should private companies be given the right to self-generate up to 100MW absent licenses.

For social-risk factors captured by the quantitative model (CVS), South Africa holds a comparatively strong old-age dependency ratio due to its young demographics – similar to other societies on the Africa continent. However, South Africa scores poorly on the CVS on labour-force participation and the level of income inequality (the latter as captured by the ratio of the income share of the 20% of persons with the highest household incomes to the 20% of persons with the lowest household incomes). A complementary QS assessment of those ‘social risks’ not captured by the CVS was evaluated as ‘weak’ compared with social-risk profiles of South Africa’s indicative peer economies. 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. Furthermore, South Africa performs comparatively weakly along healthy life expectancy (117th of 141 countries) and skills of the current workforce (101st of 141) categories of the World Economic Forum’s Global Competitiveness Index¹⁰. However, favourable growth of the working-age population (of an estimated 1.5% a year between 2023-2028, albeit easing slightly from 1.6% from 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 elevated unemployment, 40% of the population living below the lower national poverty line, high income inequality, energy and water crises, inadequate infrastructure, and logistics bottlenecks, could favour a more favourable QS assessment of social risks in the future.

Under governance-related factors captured in the CVS, South Africa scores below average on a composite index of six World Bank Worldwide Governance Indicators, although nevertheless stronger than the 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 this QS assessment, constitutional checks and balances and relative political stability are balanced by prevailing governance challenges via an aggregate assessment of ‘neutral’ against the risk profiles of ‘bb’ CVS-indicative sovereign peers. South Africa is vulnerable to civil instability with further implications for business operating conditions. The ANC’s electoral results weakened in the 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 so-called Zondo Commission. Implementation of said Commission's core recommendations is proving challenging, but their acceleration could enhance perceptions around the control of corruption and bolster business sentiment.

Rating Committee
The main points discussed by the rating committee were: i) public-debt burden; ii) Eskom debt relief; iii) budget balance; iv) economic-growth outlook; v) governance; vi) FATF grey-listing; vii) environmental risk; viii) 2024 elections; and ix) peers comparison.

Rating driver references
1. 2023 Budget Review: Government Debt and Contingent Liabilities – National Treasury of the Republic of South Africa   
2. 2022 MTBPS: Medium Term Budget Policy Statement – National Treasury         
3. 2023 Budget Review: Eskom Debt Relief – National Treasury        
4. Jurisdictions under Increased Monitoring – Financial Action Task Force   
5. Eskom Holdings Exemption – National Treasury      
6. Holdings of Domestic Bonds – National Treasury     
7. South Africa 2021 Article IV Consultation – IMF            
8. Market Data and Information – National Treasury           
9. Statement of the Monetary Policy Committee March 2023 – South African Reserve Bank 
10. The Global Competitiveness Report 2019 – World Economic Forum                     

Methodology
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.
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.

Regulatory disclosures
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 are UK-endorsed.
Lead analyst: Dennis Shen, Director
Person responsible for approval of the Credit Ratings: Dr. Giacomo Barisone, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 14 October 2022. The Credit Ratings/Outlook were last updated on 28 October 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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