In late November 2017, S&P Global Ratings downgraded South Africa’s credit rating further into junk territory, while Moody’s allowed the authorities more time to patch things up by putting them on notice of a potential downgrade in the first quarter of 2018, when a review is scheduled.
What Moody’s, and indeed market participants, were really hoping, was that after the ruling African National Congress (ANC) had elected a new leadership in December, things might change for the better. Market participants saw a likely positive turn if deputy president Cyril Ramaphosa won what was becoming a close race with President Jacob Zuma’s ex-wife and former chairperson of the African Union Commission, Nkosazana Dlamini-Zuma.
As South Africa awaits the results which will be announced on Sunday at the earlist, Thabi Leoka, an economic strategist at Argon Asset Management in Cape Town, does not believe the winner of the leadership race would be central to future ratings reviews: “Further downgrades will be determined by slower GDP growth, the inability to shrink the budget deficit and revenue shortfall, and political uncertainty should there be a lack of clear policies. Rating agencies do not rate a country on who the president is.”
John Ashbourne, Africa economist at London-based Capital Economics thought differently. When asked about the likelihood of further rating downgrades depending on who won, he said: “Yes. I think that another downgrade is the most likely outcome in either case, but it is inevitable if Ms Dlamini-Zuma is elected.”
Ashbourne’s view was that “fiscal policy will probably remain pretty stable in 2018. It may tighten a bit thereafter if Ramaphosa wins… but the change would be pretty small. A win for Ms Dlamini-Zuma would result in stable or slightly looser policy. I expect that interest rates will remain on hold in 2018, but will be loosened in 2019. Growth will accelerate in 2018 to 1.5–2%, which is better than in recent years but obviously very poor by historical or emerging market standards.”
Junk is the new cool
The S&P downgrade could have been prevented, but the mid-term budget statement by new finance minister Malusi Gigaba in late October disappointed the markets.
Gigaba’s mistake was probably to have been too honest about the state of the country’s finances. According to Argon’s Leoka, “the mid-term budget statement revealed that South Africa’s budget deficit, revenue shortfall and debt-to-GDP ratio are higher than the National Treasury’s previous projections and what the market and rating agencies had expected.
There was a breach of the spending ceiling of about R3.9bn [$286m]. The mid-term budget statement also showed that It will be very challenging to shrink the budget deficit between the mid-term statement, which was on 25 October 2017, and the budget review, which will be held end-February 2018.”
So, “fiscal policy will take some time to adjust,” says Capital Economics’ Ashbourne. Besides, “South Africa’s budget problems are primarily the result of slow growth hitting revenue, rather than over-spending by the central government. The deficit is, at the end of the day, a growth problem rather than a policy problem. So it isn’t something that Mr Gigaba (or his successor) can easily fix,” he adds.
Even so, going into 2018, market participants remain bullish. In fact, in the week after the rating downgrade by S&P, the rand was the best performing emerging market currency. And even if someone other than Ramaphosa were to become ANC leader, market participants might still yearn for the country’s assets. The global search for yield by portfolio managers is one reason why, despite rising interest rates in some parts of the developed world.
Weathering the scandals
The Zuma administration has remained impervious to myriad scandals and consequent outrage. Almost every other week or month in 2017 there were revelations in the media about an event or policy that negatively affected markets.
After a while, the markets became inured to the political noise – or most of it, at least. When rumours surfaced that Mr Zuma might be looking to implement a free education policy, market participants became skittish, for instance. State-owned enterprises are another source of investor concern. Power utility provider Eskom and South African Airways (SAA) have been particularly problematic, often headlining for the wrong reasons. In late 2017, new boards were appointed for the two firms amid investigations into alleged corruption by previous managers.
And then there are the almost 800 corruption charges hanging over President Zuma. The charges, which relate to a government arms deal in the 1990s, were reinstated by the Supreme Court of Appeal in October. The chief prosecutor, Shaun Abrahams, gave Zuma until the end of November to make submissions that could prevent charges being brought against him.
However, before Abrahams could comment on whether the submissions had been made, the High Court in Pretoria ruled that Abrahams’ appointment by President Zuma in 2015 was invalid and that Zuma could play no part in naming his successor. This judgement was being appealed by Zuma and the National Prosecution Authority at time of writing.
A key question is whether President Zuma will be gone in early 2018 or stay in office until the end of his second term. Argon’s Leoka provides insight: “There is uncertainty as to whether President Zuma will complete his term. His term formally ends in April 2019; however, should Cyril Ramaphosa become the president of the ANC, he may want to set up an inquiry into state capture as soon as possible.
“Since the president and several ministers have been implicated in corruption related to state capture, it will be very challenging for the president and ministers to remain in their positions when investigations concerning them are taking place. It will also not help Cyril Ramaphosa and thus the ANC’s campaign for the 2019 elections. Should Nkosazana Dlamini-Zuma win the ANC elections, she may maintain the status quo, allowing her to campaign for national elections in 2019, since she does not hold a cabinet post.”
Additional perspective is provided by Ashbourne of Capital Economics:“If Dlamini-Zuma wins then he will resign after securing her seat in parliament in order to give her a chance to get a few policy successes before the 2019 election. If Ramaphosa wins then there will be a struggle eventually leading to Mr Zuma being forced out.” In a nutshell, the probability he will leave office early is high.
Growth still tepid
What about the economy? With growth in investment and consumption expected to slow and unemployment stubbornly high, growth above 3% in the coming years looks unlikely. While Ashbourne doesn’t expect the economy to grow faster than about 2% over the next few years, Leoka says: “If the government adopts policies which are supportive of growth, South Africa could see higher and sustainable growth beyond 2020.”
Government functionaries have been speaking about the necessary structural reforms for a long time now, but little has been done. The tough decisions needed are politically difficult.
So even with new leadership in 2018, implementation of the necessary reforms would remain elusive. The manufacturing sector could be a key driver of growth. Agriculture, which buoyed growth in the later quarters of 2017, on base effects at least, may not drive growth significantly in 2018.
Leoka explains why: “The Western Cape and surrounding areas are still experiencing severe droughts. Since the region accounts for about 20% of total agriculture, growth in agriculture will be constrained”. In any case, “the sector only makes up about 3% of GDP, so its prominence over the past two years was a bit of an aberration,” says Ashbourne.