Moody’s Flags Downgrade Risk on BMW Retreat: South Africa Credit

A year after Moody’s Investors Service cut South Africa’s creditworthiness for the first time since the end of apartheid, the ratings company highlighted the risk of another downgrade as labor unrest dents growth.

Bayerische Motoren Werke AG’s decision earlier this month to halt expansion in Africa’s biggest economy following a three-week strike is evidence that labor strife is undermining growth, and other companies may follow, Moody’s said in a report on Oct. 12. Moody’s last downgrade came a month before Finance Minister Pravin Gordhan’s 2012 mid-term budget and was followed by rating cuts by Standard & Poor’s and Fitch Ratings. Gordhan will update his growth and fiscal projections on Oct. 23.

“The South African sovereign remains exposed to downgrade risks,” Mohammed Kazmi, an emerging-markets strategist at Royal Bank of Scotland Group Plc, said by phone from London yesterday. “The curbing of investment by the likes of BMW is another possible trigger for a downgrade. It only adds to the woes.”

Worker unrest has contributed to South Africa’s 10-year yields climbing 77 basis points this year, the most after Turkey among emerging-market nations in Europe, the Middle East and Africa, according to data compiled by Bloomberg. The nation’s sovereign risk premium has soared 84 basis points, compared with 27 basis points for similarly-rated Mexico.

Negative Outlook

Moody’s rates South African debt at Baa1, the third-lowest investment-grade level and on par with Thailand and Russia. S&P downgraded the nation in October last year to BBB, its second-lowest investment grade, and Fitch followed with a similar cut in January. Moody’s and S&P have a negative outlook on the rating, indicating they may lower it further.

BMW, the world’s largest maker of luxury vehicles, said on Oct. 3 it will cancel plans to expand following labor strikes that cost the industry as much as 700 million rand ($70 million) a day, according to the Automobile Manufacturers Employers Association.

The move “is tangible evidence of the negative impact that the increase in work days lost to strikes is likely to pose for the economy,” Moody’s said. “Such decisions are likely to be repeated by other companies when such significant losses are incurred.”

In his February budget speech, Gordhan pledged to cut spending to reduce the fiscal shortfall, estimated at 4.6 percent of gross domestic product for the year through March.

Economic Challenges

The Treasury won’t comment before Gordhan’s mid-term budget statement next week, spokeswoman Phumza Macanda said in an e-mailed response to questions yesterday.

“Steep socio-economic challenges,” including low education levels, poverty and unemployment, threaten long-term economic and political stability and constrain South Africa’s ratings, Moody’s said. The nation may face another downgrade if government raised debt levels “much further” in response to “socio-political unrest,” it said.

Moody’s declined to comment.

The timing of Moody’s statement, less than two weeks before the mid-term budget, suggests that it probably won’t cut South Africa’s rating in the near future, according to Carmen Nel, a fixed-income analyst at Rand Merchant Bank. While Gordhan may reduce his growth forecast, he will reiterate his commitment to curb spending and narrow the deficit, even with an election looming in April, she said.

Curbing Growth

“There is always a risk that the government will increase spending, but Pravin Gordhan has been quite strict about that,” Nel said by phone from Cape Town yesterday. The mid-term budget “is not going to show meaningful signs of fiscal slippage and it therefore won’t provide Moody’s with enough reason to pull the trigger on a rating downgrade.”

Strikes this year have crippled output in industries from mining to construction and aviation, undermining economic expansion and job creation in a nation where one in four people is unemployed. The disruptions may cut this year’s growth rate by 0.5 percentage point, according to Peter Worthington, an economist at Johannesburg-based Absa Bank Ltd.’s corporate and investment banking unit.

“If you look at sentiment around the labor market in South Africa, it is overwhelmingly negative,” Mohammed Nalla, head of strategic research at Nedbank Group Ltd. in Johannesburg, said by phone yesterday. “A lot of that is already priced in if you look at the rand, if you look at bond yields.”

Capital Inflows

The rand gained 0.8 percent to 9.8962 per dollar as of 4:43 p.m. in Johannesburg, paring its decline this year to 14 percent, the most out of 16 major currencies tracked by Bloomberg. Yields on benchmark 10.5 percent bonds due December 2026 dropped four basis points, or 0.04 percentage point, to 7.89 percent, an increase of 131 basis points since this year’s low on May 9.

South Africa relies on flows from abroad to help finance its current-account deficit, which reached 6.5 percent of GDP in the second quarter and will probably average 7 percent for the year, according to Moody’s. Most of that foreign capital has come from investment in stocks and bonds, inflows that can be volatile as global sentiment fluctuates.

In 2012, the South African economy attracted $4.6 billion in foreign direct investment, or 1.2 percent of GDP, according to data from the Organization for Economic Cooperation and Development. That compares with $10.8 billion in Argentina, which has a similar-sized economy to South Africa. Portfolio inflows from abroad into South Africa amounted to about $5.5 billion last year, according to the country’s central bank.

Risk Perceptions

Risk perceptions of South Africa have increased since the Moody’s downgrade on Sept. 27 last year. The cost of insuring the nation’s dollar debt against default for five years climbed 24 basis points, or 0.24 percentage point, in the period to 174.

“The three main concerns that rating agencies still have are the widening current-account deficit, the budget-deficit target likely to missed and ongoing issues in the labor market,” Kazmi at RBS said. “The curbing of investment by the likes of BMW is negative.”

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