South Africa Downgrade Was No Surprise

Investors in South Africa knew the country’s investment-grade rating was living on borrowed time.  

Action taken on South Africa by Moody’s Investors Service March 27, 2020, placed the country at “Ba1” and maintained its negative outlook.

This was not much of a surprise. Rating agencies Fitch Ratings and S&P Global both downgraded the country to below “Investment Grade” in 2017. Today,  all three agencies hold the country in a negative outlook.

“The key driver behind the rating downgrade to Ba1 is the continuing deterioration in fiscal strength and structurally very weak growth, which Moody’s does not expect current policy settings to address effectively,” Moody’s announced. “Both outcomes speak to weaker economic and fiscal policy effectiveness than Moody’s previously assumed.”

South Africa struggled to implement a credible policy or run its state-owned enterprises under the previous administration’s almost 10-year run. Growth became more volatile and government debt grew from 34.7 percent in 2010 to 62.2 percent in 2019. Cyril Ramaphosa was unable to right the ship in his two years in office and debt continued to grow and the economy stagnated leaving Moody’s no option but to downgrade the country.

“The broader erosion in institutional strength induced by the wide-spread corruption of the Zuma administration is an important factor behind the erosion in South Africa’s credit profile in recent years,” Moody’s said. “Moreover, the legacy that era has bequeathed of poor governance of state-owned enterprises remains a key drain on fiscal resources.”

The 2020 Budget announced at the end of February forecasted debt to GDP to reach 71 percent by 2022-23 with growth of just 0.9 percent. The agency expects that same ratio to hit 91 percent by 2022-23 with growth now at only 0.4 percent.  The economic fallout of the global COVID-19 pandemic is likely to further weaken these metrics.

“South Africa is entering a period of much lower global growth in an economically vulnerable position,” Moody’s said.

South Africa will now be kicked out of the World Government Bond Index (WGBI) given criteria stipulates at least one Investment Grade rating.  However, given the current market turmoil and unnatural liquidity challenges, FTSE Russell has delayed the index rebalance. While this delay may slow the exodus of debt holders tied to the index, many investors have been selling South Africa exposure since Moody’s changed its outlook to negative in November 2019.

The downgrade comes amidst growing market volatility from the outbreak and spread of COVID-19.  The South African rand touched its weakest level against the dollar amid high demand for hard currency after the downgrade. However, before the downgrade, the South Africa Reserve Bank (SARB) cut rates in its March 19, 2020, meeting by 100 bps to 5.25 percent despite a balanced view on inflationary pressures citing concerns about growth.  Additionally, it later announced it would buy government bonds to address the lack of liquidity in the market before the downgrade.

Moody’s downgrade is overshadowed by COVID-19, and the ramifications are likely to be indistinguishable from market reactions to the global pandemic and market rout. The actual downgrade effect also remains muted due to South Africa’s credit quality and poor market responses that have been telegraphed since the initial round of downgrades in 2017.

This downgrade caught no savvy global investor by surprise.