Economy heads closer to final nail in junk status coffin

● Finance minister Tito Mboweni is expected to paint a bleak fiscal picture when he presents his medium-term budget late next month, making it likely that rating agency Moody’s will put SA on alert for a downgrade to junk status when it reviews the rating in November.

Though Moody’s has a stable outlook on its South African rating for now, economists are betting this could change to negative, especially after the rating agency’s “relatively negative” comments at its annual Sub-Saharan African conference in Johannesburg this week. It warned that weak growth and bailouts for state-owned enterprises were driving SA’s public debt ratio higher and that there was no clear plan to address this.

Economists put the probability of a negative outlook in November at 50% or more.

Old Mutual Investment Group economist Johann Els has raised his probability estimate to 60%, from 30% at the beginning of this year, on the basis that the medium-term budget will show much worse deficit and debt numbers, with the R105bn Eskom bailout and underperforming tax collections more than countering any expenditure cuts the government might make.

A negative outlook could be the first step towards a junk rating by Moody’s, which is the last of the big three rating agencies that has SA on investment grade. It would have to decide whether to downgrade within 12 to 18 months, a move that could trigger outflows of capital that would put pressure on the rand and make borrowing more expensive.

Whether this week’s “relatively negative” Moody’s panel leads to a negative outlook decision on November 1 “will be determined largely by credibility: credibility of the Eskom white paper, credibility of the MTBPS [mediumterm budget policy statement] and credibility of the government’s plans to improve economic growth”, said Citi economist Gina Schoeman.

The February budget assumed the economy would grow by 1.5% this year, rising to 2.1% next year, and projected fiscal deficits of 4.5% this year and 4.3% next year. But growth is now expected to be hardly more than half of that, with Moody’s having cut its projection for this year to 0.7%.

Dire data on business sentiment published this week suggests that growth and investment could be even worse, with the RMB/BER business confidence index collapsing to a 20-year low in the third quarter of this year, prompting the RMB/BER to warn: “It would appear that more and more business people … are simply giving up hope — a concerning development and one that spells even greater trouble ahead.”

Lower than expected growth means revenue is expected to be well below February’s budget projections and with Treasury data now available for the first four months of this fiscal year, “it’s not looking good at all”, said PWC tax partner Kyle Mandy.

Growth in all the tax types was slowing, Mandy said, and a revenue shortfall of anything from R25bn to R50bn was possible. RMB economist Kim Silberman estimates the shortfall is likely to be at least R50bn.

There had been hopes that the South African Revenue Service would start collecting more effectively under new commissioner Edward Kieswetter, but Kieswetter has indicated the turnaround is going to be slower than expected. Mandy said it would take 3-5 years for the changes at Sars to have a significant impact on revenue.

The revenue shortfall will see the deficit come in higher than February estimates — Moody’s estimated it at 5.2% in June, even before the government announced the new

Mboweni’s medium-term budget statement could be a tipping point

Eskom bailout in July. But economists now expect it to be 6% or more, depending on whether and how much the government can cut spending to accommodate the bailouts.

Higher deficits will drive up the government debt ratio, which Moody’s now sees hitting 65% in fiscal 2020, even in a best-case scenario in which the government fully absorbs the Eskom bailout by cutting spending on other items and raising taxes. In a worstcase scenario, in which tax buoyancy falls further than expected and the budget takes the full Eskom hit, the debt ratio hits 70%.

Silberman expects that after putting SA on negative outlook in November, Moody’s will downgrade SA to non-investment grade in either November 2020 or March 2021.

Ask a narrow question, and you get a narrow answer. Ask rating agency Moody’s if it plans to downgrade SA’s rating, and its analysts will reply that the rating agency has SA’s outlook on “stable”, and that means it doesn’t see itself changing the rating up or down over the next 12-18 months. But we knew that already. The big question is: will the outlook still be stable after the next Moody’s update on November 1? Most economists put the chances at less than 50%. The rating agency isn’t telling if it will downgrade its outlook on SA to “negative”, which would set the clock ticking on junk status. But Moody’s has always looked at SA with a different lens, and it seems as keen as ever to avoid being the one to pitch SA over the edge. A downgrade could become a selffulfilling prophecy in that the rand could become cheaper, our debt more expensive, our economy weaker and our public finances even harder to fix.

“Please give us reason not to junk you” seemed to be the plea at the Moody’s sub-Saharan Africa conference this week, an annual event that brings together the clients, investors, bankers and economists who use ratings. Each year it seems to attract a larger crowd. This year again there were soothing noises about SA’s ratings strengths — the weakening of institutions that caused it to downgrade in earlier years has been halted, Moody’s believes, and it regards

President Cyril Ramaphosa’s administration as “reform-minded”.

But in their carefully coded ratings rhetoric, sovereign analysts Lucie

Villa and Marie Diron made their concerns pretty clear, spelling out what could trigger a downgrade — or avert it.

SA’s R3bn of public debt (and rising) is top of their watch list. It’s not the absolute amount or the level of SA’s debt-to-GDP ratio that worries

Moody’s. Rather, it is what its analysts call the direction of travel. This debt trajectory, Villa emphasised, is a key driver of the rating. And this is where what one economist calls “the scary graph” comes in.

Even in Moody’s best-case scenario, SA’s debt ratio goes to 65% in 2020 (the worst case is 70%). That may not be too far above the 60% median for other countries at the same ratings level as SA. But while our peers’ debt ratios are starting to fall, SA’s is still rising. That gap will widen if the government doesn’t cut spending, stop Eskom and other state-owned enterprises from draining the fiscus and boost economic growth.

These are credit rating agencies, remember, so what they rate is debt — specifically a country’s ability to pay the interest and, over the longer term, ultimately repay the loans themselves. It’s the two- to three-year horizon, and beyond, that matters and Moody’s makes clear it is concerned. Which is why the long-promised Eskom plan and next month’s medium-term budget statement will be so important. If they are not credible and convincing, a negative outlook is certain; and if the government doesn’t act to turn that around over the next 12-18 months, a downgrade is certain, probably before the end of next year.

In the end, though, the ratings don’t matter as much as what they reflect. The government is already borrowing just to pay the interest on its debt, which is already more than R200bn a year. It is paying in interest more than 15c of every rand it collects in tax. And as a Centre for Development and Enterprise report recently noted, the quantum of debt is weighing on our prospects — because the prospect of a ratings downgrade is affecting investor confidence, and because the more debt we have, the more expensive it becomes to finance, which raises borrowing costs across the whole economy. It’s a vicious spiral, and the longer SA leaves it, the more vicious it will be. We shouldn’t need Moody’s to tell us that.

Government is already borrowing just to pay the interest