Dagong Global Credit Rating Co., Ltd.
March 21, 2018
Dagong has decided to downgrade both the local and foreign currency sovereign credit ratings of the Republic of South Africa ("South Africa") to BBB from BBB+, each with a negative outlook. Deep structural problems in the economy further undermine South Africa’s wealth creation ability. Given the sluggish domestic demand and high fiscal deficit, the newly formed government’s reform programs can hardly make any significant progress. Due to mounting government debt and growing external vulnerabilities, government solvency in local and foreign currency is eroded.
The primary reasons for downgrading the sovereign credit ratings of South Africa are as follows:
1. Policy uncertainty has exerted pressure on South Africa’s repayment environment. Persistently high unemployment, extreme disparity between the rich and the poor, as well as government corruption have all caused serious social tensions. On February 14, 2018, ex-president Zuma was forced to resign due to corruption scandals. The new chairman of African National Congress (ANC), Ramaphosa, took over from Zuma in advance as the president, ending the "coexistence of two power centers". However, given ANC divisions, constraints from the opposition, and fiscal pressure, the new president, who is yet to consolidate his ruling foundation, will face great uncertainty during implementation of reform. Thus, South Africa’s economy will continue to be restrained.
2. The short-term economy will recover slowly whereas long-term growth lacks sufficient potential. Due to increasing political risks, South Africa's economic growth in 2017 was only 0.9%. In the short term, significant uncertainty of policy will reduce the positive impact brought on by new policies, aiming to improve employment and reform state-owned enterprises. Hence, domestic demand will make limited improvements. Fiscal consolidation measures including increases in taxes and reductions in transfer payments will further curb investment. Thus, South Africa’s economy is expected to achieve slow growth rates of 1.2% and 1.5% in 2018 and 2019, respectively. In the medium term, the country’s structural problems, including shortage of skilled labor, inadequate infrastructure, and economic equality, will not be effectively tackled. Therefore, economic growth will average around 2.0%.
3. A widening fiscal deficit and the government’s increasing dependence upon debt financing will undermine the security of repayment sources. Slow economic growth will render tax revenue growth weak. Higher education reform and financial predicaments facing SOEs will increase the government’s fiscal burden. That, combined with livelihood issues and growing interest expenses, leads to greater repayment pressure facing the government. South Africa’s general government fiscal deficit is projected to rise to 4.1% and 4.3% in 2018 and 2019, respectively, while the ratio of government financing needs to fiscal revenues at the same period will increase to 44.6% and 45.6%, thus signifying heavier dependence upon debt financing. As a result, government repayment sources will be less secure.
4. Climbing government debt and worsening external vulnerability will weaken government solvency. Due to slow economic growth and a high fiscal deficit, it is forecasted that the ratio of general government debt to fiscal revenues in 2018 and 2019 will rise to 194.7% and 204.0%, respectively. As of March 2017, South African government’s contingent liabilities arising from guarantees to SOEs amounted to about 18% of GDP. Poor operation and grave financing difficulties facing SOEs will significantly increase the risk of contingent liabilities for the government. As of September 2017, South Africa’s gross external debt was 47.5%, and by year end 2017, international reserves on short-term external debt decreased by 8.2 percentage points to 150.8% year-on-year. The proportion of foreign currency-denominated debt is less than 50%, yet a rising current account deficit and increasing capital outflow pressure will exacerbate external vulnerabilities. The South African rand continues to face great devaluation pressure, and solvency in foreign currency will deteriorate.
In the short term, the new president has yet to consolidate his power, thus bringing about the currently existing policy uncertainty; wealth creation capacity will be weak and government finances will continue deteriorating. Therefore, the debt burden will keep rising and government solvency will be under pressure. In summary, Dagong has decided to adopt a negative outlook for the local and foreign currency sovereign credit ratings of South Africa for the next one to two years.