Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of South Africa’s long-term local- and foreign-currency issuer and senior unsecured debt-category ratings at BB and maintained the Stable Outlooks. The short-term issuer ratings have also been affirmed at S-3 in local- and in foreign-currency, and Stable Outlooks are maintained.

The affirmation of South Africa’s BB long-term ratings represents multiple credit strengths, including: i) the size, sophistication and diversification of the domestic economy – the largest of the African continent; ii) a strong public debt structure, including long average maturities of sovereign debt, debt denominated predominantly in domestic currency and a diverse domestic and foreign investor base; iii) a robust monetary-policy framework; and iv) the resilient banking system and deep domestic capital markets. The rating furthermore considers South Africa’s standing in regional and international financial institutions and associated access to bilateral and multi-lateral funding channels adding to financing flexibility.

The main challenges for South Africa’s credit ratings represent: i) a still-rising government debt burden – driven by elevated headline deficits and the crystallisation of contingent liabilities; ii) modest economic-growth potential, enervated by long-standing energy and transport infrastructure bottlenecks and associated constraints for economic competitiveness; iii) governance challenges longer run; and iv) socio-economic vulnerabilities such as elevated unemployment and income inequality hindering budgetary consolidation and structural reform.

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Key rating drivers

A large and well-diversified economy. South Africa has the largest economy (nominal GDP of around USD 401bn as of 2024) of the African continent, and comparatively elevated GDP per capita (USD 5,975) compared against sub-Saharan Africa regional averages. The diversified South-African economy centres around a robust tertiary sector (accounting for nearly 70% of value added), supporting economic resilience against external-sector crises and mitigating exposures to commodity-price cycles. Furthermore, South Africa’s global significance as the only African member state of the G-20 and upcoming presidency of the G-20 enhances political clout. BRICS membership strengthens South-South cooperation while access to multi-lateral financing from African and other international financial institutions, including a USD 4.3bn Rapid Financing Instrument extended from the International Monetary Fund during pandemic crisis peaks, provides for financing flexibility.

Favourable debt structure and strong market access. Public debt is mostly fixed-rate (which account for 71.5% of outstanding domestic bonds¹), denominated in local currency (around 90% of the debt stock) and has a long average maturity (of 12 years)². Short-term treasury bills represented (only) 11% of the domestic debt stock as of July 2024¹. This sound public-debt structure helps mitigate interest-rate, forex and debt roll-over risks. Since March of this year, the rand has strengthened exiting a phase of structural currency weakening with a core driver being bettered investor confidence during a prolonged phase absent power outages alongside a comparatively investor-friendly outcome of May general elections.

South Africa furthermore benefits from deep domestic capital markets, which provide the government with access to a diversified group of investors including pension funds and insurance companies, and the ability to issue debt across a range of maturities and instruments. This enables South Africa to fund the bulk of gross annual borrowing requirements via the domestic markets, providing the sovereign with liquidity and limiting dependencies on fragile international investor sentiment.

Robust monetary policy framework and a resilient banking system. The South African Reserve Bank (SARB) is highly regarded in international debt capital markets aided by sound independence from the national government, a proven track record of management of inflation, and sophistication and efficacy of monetary-policy execution. SARB operates within a well-regulated domestic banking system that serves as a crucial conduit of monetary policy for the real economy, especially crucial in view of hindrances for the monetary transmission from an expansive system of wage bargaining and given the strength of trade unions. In July, inflation declined to 4.6% year-over-year – reaching close to the mid-point of the central bank’s 3-6% target range, strengthening expectation of a SARB rate cut later this month.

The fundamentals of the banking system remain sound as reflected by adequate system-wide tier-1 ratios (of 14.8% of risk-weighted assets as of June 2024). These strong fundamentals enhance system-wide resilience to a degree of deterioration of asset quality amid still-elevated financing rates. Non-performing loans have risen moderately over the recent years to 5.5% of gross loans by June of this year. The sound banking system is supported by the regulatory oversight of SARB with the domestic financial framework in line with Basel-III requirements. Nevertheless, the economy faces regulatory weaknesses within its money-laundering oversight. South Africa was added to the Financial Action Task Force greylist in February of 2023. While some progress has been made on identified shortcomings, addressing remaining action items represents a significant challenge. South Africa could exit the greylist by June or October of 2025 at the earliest, if all remaining shortcomings are addressed sufficiently and sustainably.

Rating challenges: structurally-increasing government debt, moderate growth potential, and governance challenges.

Despite recent robust government-revenue performance, spending pressures are anticipated to rise over the coming years due especially to rising debt-servicing payments, outstanding social-spending programmes and ongoing support for the state-owned enterprises, such as debt relief for Eskom until the fiscal year (FY) 2025-26. These factors are likely to hinder budgetary-consolidation efforts and hold the general government debt ratio on a structurally-increasing path – reaching 80% of GDP by 2028. This forecast contrasts against government expectations of debt beginning a structural decline by FY2025-26. Nevertheless, Scope public-debt projections have been improved since the Agency review of the credit earlier this year. During the Budget Review this past February, the government announced plans to utilise ZAR 150bn of the Gold and Foreign Exchange Contingency Reserve Account of SARB over three years for reducing borrowing requirements and resultantly bolstering the sovereign-debt path. This intervention should moderate the debt-to-GDP ratio by several percentage points over the forthcoming years. Furthermore, a recent reform allowing for early withdrawals from pension funds effective 1 September 2024 delivers a modest short-run boost for household consumption – presenting marginal relief for the government debt trajectory near term even if the reform does not represent a long-run solution for fiscal sustainability.

South Africa initiated an ambitious reform agenda – the so-called Operation Vulindlela – since October of 2020, aiming to address core macro-economic challenges, although progress has been slow and the estimate of the medium-run economic growth potential of the economy (1.5%) has so far been left unchanged by Scope. A record of power outages and infrastructure (especially in rail) bottlenecks alongside rigidities of the labour market remain credit constraints. It remains to be seen whether recent improvements of the performance of Eskom resulting in no load-shedding incidents since end-March of this year are sustainable. GDP grew 0.4% quarter-on-quarter seasonally adjusted last quarter, slightly under market expectations. After slowdown last year to annual growth of 0.6%, Scope anticipates modest growth of 0.8% for 2024 before an estimated 1.4% growth next year.

During elections this past May, the African National Congress (ANC) lost its parliamentary majority for the first time since the end of Apartheid. After intense negotiations, ANC formed a multi-party unity coalition of which the main partner is the Democratic Alliance (DA). Cyril Ramaphosa has been re-elected as President. Only more than two months into the new parliamentary term, uncertainty remains regarding the scope of ambition of the coalition government on structural reform and maintenance of a prudent budgetary stance.

Outlook and rating sensitivities

The Stable Outlook represents the view that risks for the ratings over the next 12 to 18 months are balanced.

Downside scenarios for the long-term rating and Outlooks are if (individually or collectively):

1. The public-debt burden continues to rise driven by delays of budgetary consolidation, rising interest costs and/or additional support being demanded for the state-owned enterprises;
    
2. The economic-growth outlook remains subdued, exacerbating socio-developmental challenges;
    
3. The external-sector risk profile weakens, evidenced by a material decline of foreign-currency reserves and/or renewed depreciation of the rand; and/or
    
4. Governance challenges re-escalate.

Upside scenarios for the long-term rating and Outlooks are if (individually or collectively):

1. Sustained budgetary consolidation boosts confidence in the medium-run stabilisation of the public-debt ratio through the cycle;
    
2. Reforms addressing long-standing fundamental challenges enable a material rise of growth potential mitigating socio-economic risks;
    
3. External-sector risks are redressed, such as the significant bolstering of foreign-currency reserve stocks; and/or
    
4. Governance challenges are tackled on a sustainable basis.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals an initial indicative credit rating of ‘bb+’ for South Africa. Under Scope’s methodology, this initial indicative rating receives: i) no further adjustment from the methodological reserve-currency adjustment; but ii) a one-notch negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘bb’ is assigned for South Africa and next reviewed by the analyst-driven Qualitative Scorecard (QS) – where this indicative rating can be adjusted by up to three notches up or down depending on the significance of South Africa’s qualitative credit strengths or weaknesses compared against an SQM-assigned peer group of sovereign states.

Scope identified the following relative credit strengths of South Africa via the QS: i) monetary policy framework; ii) debt profile and market access; iii) external debt structure; and iv) banking sector performance. Conversely, the following QS-category credit weaknesses of South Africa were identified against the sovereign’s peer group: i) growth potential and outlook; ii) fiscal policy framework; iii) social factors; and iv) governance factors. On the aggregate, the QS generates no net adjustment for South Africa’s credit rating, concluding in final BB long-term issuer ratings.

A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process via the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

On environmental factors, South Africa scores weakly under the SQM due to high carbon-emissions intensity. It furthermore scores weakly on vulnerability to natural disasters, as captured by indices published by the Notre Dame Global Adaptation Initiative. The ecological footprint of consumption relative to South Africa’s available biocapacity is displayed also as being comparatively weak. The complementary qualitative QS assessment of ‘environmental factors’ not already considered by the SQM is evaluated as ‘neutral’ against bb model-indicative sovereigns, in view of challenges for the transition to a decarbonised energy architecture, also given significant effects for core mining and manufacturing sectors of this transition. Reducing heavy reliance on coal (accounting for some 79% of electricity production³), diversifying the mix of energy sources, and investments 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 enhancing 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. The debt overhang of Eskom, and the state-owned enterprise’s “unbundling”, could furthermore delay progress around net-zero.

For social factors captured by the quantitative model (SQM), South Africa holds a comparatively strong old-age dependency ratio due to young demographics – like other societies of the African continent. However, South Africa scores poorly under the SQM on 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 already captured by the SQM was evaluated as ‘weak’ compared against social-risk profiles of South Africa’s ‘bb’-indicative sovereign peers. 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 2019 Global Competitiveness Index. Nevertheless, meaningful growth of the working-age population (of an estimated 1.4% a year between 2024-2029) bolsters potential 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, just over 40% of the population living beneath the lower middle-income poverty line, high income inequality, energy and water crises, inadequate infrastructure, and logistics bottlenecks, could favour a more favourable assessment on the QS social-factors category later on.

Under governance-related factors captured by the SQM, South Africa scores below average on the 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 under the complementary QS analyst assessment. In this QS assessment, constitutional checks and balances and comparative political stability are balanced against prevailing governance challenges via an aggregate assessment of ‘weak’ against the risk profiles of ‘bb’-indicative sovereign peers of South Africa. South Africa is vulnerable to civil instability with further implications for business operating conditions. The ANC remains the dominant political grouping after May elections. However, after losing its parliamentary majority, the party formed a coalition with DA and smaller political groupings. A coalition government at the national level is unprecedented post-Apartheid – speaking to favourable steps for healing racial, ideological and political divisions long run.

Rating committee
The main points discussed by the rating committee were: i) rating history; ii) peer rating agencies; iii) 2024 general elections; iv) public-debt and budget-balance expectations; v) economic outlook; vi) external sector; vii) budgetary policy and fiscal rules; and viii) Eskom reform and the energy sector.

Rating driver references
1. National Treasury (Republic of South Africa): Outstanding Government Debt.
2. International Monetary Fund – South Africa: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for South Africa (6 June 2023).
3. Centre for Renewable & Sustainable Energy Studies: Visualisation of South African Energy Data (Last Updated: July 2024).

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), 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 and/or Outlooks 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, Senior Director
Person responsible for approval of the Credit Ratings: 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 6 October 2023.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.