Scope downgrades South Africa's credit ratings to BB, revises Outlooks to Stable
For the associated Rating Review Annex, click here.
Scope Ratings GmbH (Scope) has today downgraded the Republic of South Africa’s long-term foreign- and local-currency issuer and senior unsecured ratings to BB and revised the Outlooks to Stable, from Negative. 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 one-notch downgrade of South Africa’s credit ratings to BB reflects the pursuant two credit-rating drivers:
A rising government-debt burden as a result of elevated headline deficits as well as crystallisation of contingent liabilities; and
- A weakening of the economic growth outlook, hindered by modest economic growth potential due to inadequate energy and transport infrastructure and persistently elevated unemployment.
Governance challenges and socio-economic vulnerabilities such as elevated income inequality hindering structural reform and budgetary consolidation are further credit constraints.
Nevertheless, South Africa’s BB long-term credit ratings reflect multiple credit strengths such as: i) the size and diversification of the domestic economy – among the 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) resiliency of the banking system, an advanced financial system and deep capital markets. The ratings also consider South Africa’s weight in regional and international financial institutions and access to bilateral and multilateral funding channels.
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 downgraded if, individually or collectively: i) the public-debt burden continues to rise due, as an example, to delays in budgetary consolidation, further rises in the interest burden and/or additional support being demanded 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 material decline in foreign-currency reserves and/or additional depreciation in the rand; and/or iv) governance challenges were to escalate.
Conversely, the ratings/Outlooks could be upgraded 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 socio-economic risk; and/or iii) external-sector risks are further redressed, such as a significant bolstering of foreign-currency reserve stocks.
The first driver of the rating downgrade reflects a rising government-debt burden given elevated headline deficits and crystallisation of contingent liabilities.
There has been a rise of the sovereign’s public-debt burden, which remains elevated by emerging-market standards. Scope has historically assumed a rising trajectory of South African debt as its baseline expectation. Under the debt sustainability analysis, the agency sees government debt rising to 77.5% of GDP by 2025 and nearly 90% of GDP by 2028, from 56% in 2019 and 24% at 2008 lows. This represents a steeper trajectory than that forecast as of October 2022. Furthermore, under a downside economic scenario akin in severity to the global financial crisis, government debt exceeds 100% of GDP by 2028. Hence, a government expectation under its 2023 Budget Review1 of a peak of the public-debt ratio at a level of nearly 74% by fiscal year (FY) 2025/26 appears optimistic. The government had previously forecast, under the 2022 Medium Term Budget Policy Statement (MTBPS)2, debt-to-GDP to peak at 71% by FY2022/23.
As relevant, net interest payments are a growing burden on the national budget – expected to represent around 19% of general government revenue during this calendar year, before rising to 29% by 2028 under a baseline scenario. Net interest payments accounted for only 8% of government revenue as of 2008. Referenced figures are meaningful particularly when compared against that of other bb-rated sovereign borrowers: namely, Georgia (net interest payments of 4% of revenue as of 2023, 5.5% by 2028), Serbia (4% in 2023, nearly 5% by 2028), and Morocco (8.5% in 2023, 8.5% by 2028).
10-year treasury yields stand presently around 11% – a rise from the 8.5% in early 2022. Demand for long-end bonds has been affected by growth and fiscal risks, with the South African Reserve Bank (SARB) sounding alarm earlier in this year of domestic investors being reluctant to absorb issuance. Driven by higher financing costs, annual gross government financing requirements are seen at about 21.2% of GDP by 2028, above the 15% IMF threshold of more restricted fiscal space for emerging-market issuers. Adjustments to issuance plans are anticipated to be announced in the medium-term budget presentation scheduled for 1 November.
The South African government has prudently taken on a part of state-owned utility Eskom's debt, equivalent to approximately 3.4% of GDP, through a debt-relief operation3. While the aggregate contingent liabilities of the government are not exceptionally high, weaknesses in the balance sheets of some SOEs, particularly in the electricity and transport sectors, raise concerns about the potential of further liabilities crystallising on the government balance sheet.
The general government deficit declined to roughly 4.5% of GDP in FY2022/23 as the budget outperformed earlier government objectives. Nevertheless, the deficit is seen re-rising to 6% for FY2023/24 ahead of the coming elections as tax revenues have underperformed and given higher-than-budgeted wage growth, before averaging 7.3% between fiscal years 2024/25 and 2028/29. This assumption of meaningful deficits medium run is comparatively pessimistic compared with government projections for the consolidated budget deficit to narrow from 4% of GDP during FY2023/24 to 3.2% by FY2025/26. The government’s assumption, in the 2023 Budget, for the 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, seems optimistic considering a record of (modest) primary deficits over the decade before Covid-19.
The government approved a further extension of the Covid-19 Social Relief of Distress (SRD) by a year until end-March 2024. There is pressure to further extend SRD. Spending rises and non-observation of nominal expenditure ceilings since FY2018/19 are a concern – calling into question reliability of the fiscal framework. Scope would consider the adoption of a debt-ceiling rule complementing the existing nominal expenditure ceiling as being credit positive. Treasury positively plans consideration of reductions in the number of government departments and state-owned entities in the forthcoming mini-budget, and has adopted several spending cuts, including a hiring freeze and a halt of procurement contracts for infrastructure projects. But fiscal pressures will remain significant given structural social-spending requirements. Risks to the budgetary outlook include: i) renewed economic recession bringing lesser tax revenue and curtailed spending discipline; ii) settlement for higher wage hikes; iii) a further extension or permanent inclusion of the SRD – which the government considers absent a permanent source of funding might impair the sustainability of public finances; iv) greater-than-anticipated aid for SOEs; and/or v) higher-than-anticipated borrowing costs (especially given outstanding inflation-linked domestic debt).
The second driver of this credit downgrade is a weakening of the economic growth outlook, characterised by modest economic growth potential, and constrained by unsatisfactory energy and transport infrastructure and elevated unemployment.
After a post Covid-19 crisis economic rebound, Scope expects economic growth to ease to 0.9% this year – falling below its potential rate estimated around 1.5% a year. This is before moderate recovery to 1.3% growth next year. South Africa’s growth is held back by persistent energy (record power outages) and infrastructure (especially in rail and ports) 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. Unemployment is seen averaging an elevated 33% in 2023 before 33.9% in 2024. The employment crisis challenges economic potential and social cohesion, and adversely affects spending requirements and fiscal sustainability. However, 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 Q2 2023, over 70% of reform milestones are either completed or on track to be finalised inside the next year4.
Present governance challenges are considered in the ratings. The African National Congress (ANC) received under 50% of the nationwide vote during 2021 municipal elections for the first time, and there is a possibility of ANC needing to rule in coalition following 2024 general elections – presenting greater policy uncertainties. Deficits in anti-money laundering and counter-terrorism financing were highlighted in the February 2023 decision of the Financial Action Task Force (FATF) to list South Africa as a “jurisdiction under increased monitoring”5. The 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 to temporarily lift some disclosure requirements and publish irregular, fruitless and wasteful expenditure only in Eskom’s annual reporting for three years6 – before promptly withdrawing this exemption – underscores governance risks. South Africa’s scores on the World Bank Worldwide Governance Indicators have declined in the last decade.
The external sector has strengthened but remains a vulnerability during phases of emerging-market capital outflow. South Africa returned to a current-account deficit (of 0.5% of GDP) last year, after consecutive years of current-account 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 25.6% of outstanding domestic securities in August) remains a risk – even after recent exits of foreign investors7. The nominal effective exchange rate has weakened 10% since the start of the year.
Nevertheless, the central bank has constructively held a long-running policy of refraining from exchange-rate interventions. Net international investment assets aggregated to a robust 31% of GDP as of Q2 2023. Pre-pandemic current-account deficits were predominantly financed by substantive portfolio equity and debt investment. External debt stood at only 41% of GDP as of Q2 2023 with only a little over a half of this in foreign currency. Nearly 80% of outstanding external debt is long-term. The floating exchange rate enables rand depreciation to act as a shock absorber during external crises and limit the drawdown of official reserves. Foreign-exchange reserves (of USD 47.4bn as of August 2023) cover, however, only 88% 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% coverage of the early 2010s.
Nevertheless, South Africa’s BB ratings reflect meaningful credit strengths.
Firstly, the credit standing is anchored by the country’s large and well-diversified economy. South Africa has one of the largest economies (nominal GDP of around USD 382bn 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 70% of value added) and manufacturing (14%) sectors, supporting economic resilience against external shocks and mitigating exposure to commodity-price cycles. Furthermore, South Africa’s economic importance translates to substantive political clout within the region and globally. South Africa is the only African member state of the G-20. The BRICS – this year expanded to 11 Member States – could furthermore support the sovereign if it anchors South-South cooperation and curtails dependencies on the dollar and SWIFT payment system long run. Finally, 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 favourable debt profile and strong market access. Public debt is mostly fixed-rate (accounting for 71% of domestic bonds), denominated in local currency (around 88% of the debt stock) and has a long average maturity (of 12 years)8. Short-term treasury bills represented only 11% of the domestic debt stock as of August 2023.9 This sound public-debt structure curtails interest-rate, forex and debt roll-over risks amid global monetary tightening and rand weakening. 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 (accounting for about 23% of domestic bonds outstanding). This enables South Africa to fund the bulk of its gross borrowing requirements via the domestic market and limit dependencies on fragile foreign investor sentiment.
The third factor underscoring BB credit ratings is a robust monetary policy framework. The South African Reserve Bank 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. 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 the monetary transmission from a system of wage bargaining and given the strength of trade unions. Inflation declined to 4.8% in August (from 7.8% as of July 2022 peaks) – near the mid-point of the central bank’s 3-6% target range, and Scope expects headline inflation to average 5.8% in 2023 before 5.0% in 2024. Core inflation had also slightly moderated to 4.8% by August, but inflation risks remain. In September, SARB held rates unchanged at 8.25%10. Scope expects the central bank to appropriately hold policy rates at 8.25% through the end of 2023, before trimming rates to 7.5% by the 2H of 2024.
Finally, the BB ratings of South Africa reflects a resilient banking system and financial sector. Banking-system fundamentals are sound as reflected in adequate system-wide tier-1 ratios (15.2% of risk-weighted assets as of August 2023). Sound banking-system fundamentals raise system-wide resilience to a degree of deterioration in asset quality amid elevated rates. Non-performing loans rose steadily to a still moderate 5.4% of gross loans by August. 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 provide banks with ample liquidity, reducing reliance on foreign-currency financing and diminishing exposure to large refinancing risk.
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 assessments.
For South Africa, the following relative credit strengths are identified in the QS: ‘monetary policy framework’; ‘debt profile and market access’; ‘external debt structure’; ‘banking sector performance’; and ‘financial imbalances’. Conversely, ‘growth potential of the economy’; ‘fiscal policy framework’; ‘debt sustainability’; ‘social factors’; and ‘governance factors’ are identified in the QS as being credit weaknesses based on a comparison against the credit’s ‘bb’-indicative sovereign peers.
The combined relative credit strengths and weaknesses under the QS generate no net adjustment to the indicative ratings, signalling final ‘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 factors, South Africa scores weakly on the CVS due to high carbon-emissions intensity. It furthermore scores weakly on 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 factors’ 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 (accounting for 70% of energy and some 85% of electricity), diversifying the mix of energy sources, and investing in renewables are priorities. Rehabilitation of domestic electricity production capacity, such as the extension of the life of the Koeberg nuclear power station, coupled with raising of supply via renewable energy, 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.
For social factors captured by the quantitative model (CVS), South Africa holds a comparatively strong old-age dependency ratio due to its young demographics – like other societies on the Africa continent. However, South Africa scores poorly on the CVS on its labour-force participation and the level of income inequality (the latter as captured by the income share of the bottom 50% of the population). A complementary QS assessment of ‘social factors’ not captured by the CVS was evaluated as ‘weak’ compared with social-risk profiles of South Africa’s ‘bb’-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 examples 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 Index11. However, favourable growth of the working-age population (of an estimated 1.5% a year between 2023-2028) raises potential output growth, even if this furthermore drives a present employment crisis. South Africa’s reconstruction and recovery programme, aiming to address challenges such as elevated unemployment, 40% of the population living under the lower national poverty line, high income inequality, energy and water crises, inadequate infrastructure, and logistics bottlenecks, could favour a more favourable QS assessment for social factors 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 institutional risks via a ‘governance factors’ analytical category in the complementary QS analyst assessment. In this QS assessment, constitutional checks and balances and relative political stability are balanced by prevailing significant governance challenges vis-à-vis an aggregate assessment of ‘weak’ against the risk profiles of ‘bb’-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 Jacob Zuma were highlighted by the so-called Zondo Commission. Implementation of said Commission's core recommendations is proving challenging, although their acceleration could enhance perceptions around the control of corruption and bolster business sentiment.
The main points discussed by the rating committee were: i) public-debt and interest-payment burden; ii) yield dynamics and budget deficit; iii) economic-growth outlook; iv) governance; v) 2024 elections; vi) fiscal-consolidation plan; vii) structural reforms; and viii) sovereign 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. Operation Vulindlela: Progress Update (Q2 2023 Report) – the Presidency of the Republic of South Africa
5. Jurisdictions under Increased Monitoring – Financial Action Task Force
6. Eskom Holdings Exemption – National Treasury
7. Holdings of Domestic Bonds – National Treasury
8. South Africa 2023 Article IV Consultation – IMF
9. Market Data and Information – National Treasury
10. Statement of the Monetary Policy Committee September 2023 – South African Reserve Bank
11. The Global Competitiveness Report 2019 – World Economic Forum
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2023), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Core Variable Scorecard 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 Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and 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/Outlooks were first released by Scope Ratings on 14 October 2022. The Credit Ratings/Outlooks were last updated on 21 April 2023.
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.
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