Absa expects more downgrades for SA

SA is likely to suffer further ratings downgrades as the economy struggles to recover from the devastating effect of Covid-19 and recent unrest, while spending pressures on the government continue to weigh on the country’s fiscal debt position, says Absa.

SA is likely to suffer further ratings downgrades as the economy struggles to recover from the devastating effect of Covid-19 and recent unrest, while ongoing spending pressures on the government continue to weigh on the country’s fiscal debt position, says Absa.

Though Absa welcomed recent policy decisions such as the lifting of the licensing threshold for embedded electricity generation to 100MW, it said that without much more aggressive structural reforms further credit rating downgrades are “more likely than not”.

Absa also said strong commodity exports that have helped push SA’s current account into a notable surplus while boosting tax revenue for the government would not be enough to counter increasing fiscal spending pressures that leave the country’s debt-to-GDP ratio on a tenuous path.

“We still have a big fiscal issue,” said Peter Worthington, a senior economist at Absa.

“We will continue to see debt-to-GDP rise over the next couple of years. We’re probably more likely to see further rating downgrades at some point.”

SA’s debt is rated below investment grade by all three major credit ratings agencies, with S&P Global Ratings and Fitch Ratings both assigning a BB- assessment, three levels below investment grade.

Moody’s Investors Service, which rates SA one notch higher, said on May 18 the country was at risk of a further downgrade should economic growth remain weak as the high interest rates the government was borrowing at meant debt levels would continue to rise.

“Our forecast is that we’ll probably see Moody’s downgrade us again, unfortunately,” said Worthington, adding that ratings agencies typically observed an unofficial rule of thumb not to maintain a directional outlook on a country’s assessment for much longer than 18 months.

“At that point the country should’ve either sufficiently strengthened that you can move back to a stable outlook or enough has happened in either the positive or negative direction that you actually act on it with a rating change,” said Worthington.

Though Absa expects SA’s economy to grow by 4% in 2021, this would still leave GDP below its pre-pandemic levels after the 7% contraction in 2020 in the wake of the pandemic, which was the biggest economic slump in a century.

Absa also expects mediumterm economic growth to average only about 1.9%, but said downside risks could push this to as low as 1%.

“You cannot with 1% growth get debt-to-GDP to stabilise unless you think government would be prepared to take a huge machete to expenditure and cut the deficit dramatically,” said Worthington.

Absa says recent wage settlements in the public sector, economic support measures in the wake of recent unrest and the extension of the social relief of distress grant would result in a budget deficit of 8.5% of GDP in the 2021/2022 fiscal year.

Worthington said the public sector wage deal will cost the government about R18bn, or 0.3% of GDP, which was more than was budgeted for in February 2021. The extension of the social relief of distress grant will cost R27bn, which along with other economic support measures in the wake of recent unrest would have to be funded out of the excess tax revenue earned as a result of high commodity prices, he said.

“All this generates a debt trajectory that is still very challenging,” said Worthington.

Absa forecasts that SA’s fiscal debt load will continue to rise over the next few years, from 78.8% of GDP at the end of the last fiscal year to 85.3% at the end of fiscal 2023/2024, before peaking at 87.5% of GDP in 2025/2026.

However, this trajectory does not include the roughly R565bn in contingent liabilities that may have to be transferred to the Treasury’s balance sheet from debt guarantees provided to state-owned entities.

Absa says Eskom alone will need to be relieved of at least R200bn-R250bn of debt that is likely to be transferred to a special-purpose vehicle that will be repaid with “concessional climate-related financing”.

On the positive front, Absa said inflation had remained well anchored near the midpoint of the Reserve Bank’s 3%-6% target range for some time, allowing policymakers to keep interest rates lower for longer. Absa expects inflation to average 4.7% in 2021 and 4.1% in 2022.

Worthington expects the first rate rise to occur in March 2022.