Zuma's Policy Jam Caught in Headlights as Debt Hovers Above Junk

  • Growth at 6-year low, rates at 2010 high compound SARB dilemma
  • Credit downgrade by Fitch, outlook cut by S&P add to quandary

If investors needed reminding about the quandary facing South Africa’s central bank, they just got it from two credit-rating companies.

While statements on Dec. 4 from Standard & Poor’s and Fitch Ratings left the country’s debt short of a downgrade to junk, both companies gave the same diagnosis for South Africa’s economic malaise: government policies that are denting business confidence and the likelihood of state funding or guarantees that will further strain the budget of President Jacob Zuma’s administration.

The assessments get to the heart of the dilemma facing Reserve Bank Governor Lesetja Kganyago, who is struggling to keep the weakening rand from fueling inflation at a time when interest rates at their highest level in five years have left gross domestic product growing at its slowest pace since 2009. Throw in the looming prospect of the U.S. Federal Reserve’s first rate increase in almost a decade -- an event likely to accelerate the capital exodus from Africa’s second-biggest economy -- and the task becomes greater still.

“The Reserve Bank is sitting in a classic stagflationary bind, so one has to
feel very sorry for them,” George Herman, head of South African investments at Cape Town-based Citadel Investment Services, said by phone on Dec. 5. “The Reserve Bank is not where the problem lies. The problem is that the government doesn’t see growth as the biggest crisis in the country.”

Fitch cut South Africa’s credit rating one level on Friday to BBB-, the lowest investment grade, and in line with the assessment of S&P’s, which lowered its outlook to negative from stable. The country’s growth potential has deteriorated further, Fitch said, which also cited the government’s decision not to tighten fiscal policy in the face of weakening revenue and rising debt levels. Flexibility around the budget might reduce because of risks associated with funding needs of state-owned companies, S&P said.

The nation’s economy narrowly avoided a recession in the third quarter, posting 0.7 percent annualized growth after a contraction the previous three months as electricity shortages, low global demand and falling metal prices stifled output.

Top of Agenda

“Slow growth will be at the top of the Monetary Policy Committee’s agenda,” Dawie Roodt, chief economist at Efficient Group Ltd. in Pretoria, said by phone. “But they can’t do anything about it.”

Forward-rate agreements used to speculate on interest rates on Dec. 4, before the rating company announcements, predicted a 64 percent chance of a 25 basis-point increase in borrowing costs at the MPC’s first meeting of 2016 on Jan. 28 , compared with a 24 percent likelihood a week earlier.

Fitch’s second downgrade for South Africa in three years puts its rating on par with India and Turkey. The rand dropped to a record low of 14.5629 per dollar on Monday before paring some of its losses to 14.5478 as of 5:54 p.m. in Johannesburg. Yields on rand-denominated government bonds due December 2026 rose 10 basis points, the most since Oct. 21, to 8.76 percent, the highest since February 2014 on a closing basis.

The cost of insuring against a default by South Africa’s government for five years using credit-default swaps surpassed that of Turkey, which is embroiled in the Syrian conflict and threatened with sanctions by Russia, on Oct. 23, two days after the government widened its budget-deficit targets and the day riot police battled protesting students on the lawns outside Zuma’s office in the capital, Pretoria. The South African contracts rose 2 basis points to 282 on Dec. 4, the highest since Oct. 2.

“Many foreign investors will see the decision by S&P to revise our credit rating to negative as a precursor to a full ratings downgrade to junk status and could start to position their investment for that eventuality rather than wait for the actual downgrade,” said Kevin Lings, the chief economist of Stanlib Asset Management. “The government needs to urgently address the growth, policy and public-sector debt concerns.”

Finance Minister Nhlanhla Nene cut tax-revenue projections in his mid-term budget in October because of slowing growth forecasts, reducing the government’s ability to rein in the fiscal deficit as quickly as targeted.

The Treasury has enough foreign-currency deposits to repay its debts and the government needs to improve economic growth by stabilizing the power supply, changing labor rules to avoid protracted strikes and improving the governance of state-owned companies that are draining resources, the ministry said in an e-mailed statement on Sunday.

The government’s ability to carry out reforms is hamstrung by ideological differences in the ruling alliance, made up of the African National Congress, South African Communist Party and the Congress of South African Trade Unions, Peter Attard Montalto, an emerging-markets economist at Nomura, wrote in a note.

“South Africa will not avoid going over the investment grade/junk-cliff edge given a lack of urgency on structural reforms,” he said. “The statement from S&P pulls this forward to be a much more immediate risk given its focus on downside growth risks and additional support needed for parastatals.”

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