SA edges closer to junk rating

South Africa's sovereign credit rating slid to the brink of "junk" status on Friday after Standard & Poor's unexpectedly changed the outlook on its BBB-assessment of the country's creditworthiness to negative from stable, citing its faltering pace of economic growth and the shaky balance sheets of state-owned enterprises.

The decision means there is at least a one-in-three chance that South Africa will end up with a speculative credit rating within the next year or two, which will raise the government's cost of borrowing, dampen foreign investor appetite for domestic shares and bonds, and deliver a severe blow to the weakening rand.

S&P's comments were relatively sanguine about the country's debt dynamics, despite receding budget deficit targets, falling tax revenues and lower prices for the commodities that South Africa exports - a strong signal of faith in the Treasury's ability to manage the country's finances.

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But it highlighted the absence of meaningful economic policy reform, noting that delays to legislation for the mining sector, labour market and trade negotiations, along with the lack of intervention to support industry, were impairing business confidence and discouraging investment by the private sector.

"At the heart of it is the poor growth story - part of it is the global environment - but part of it is domestic," said S&P primary credit analyst Ravi Bhatia. "There has been no definitive reform package which has led to an increase in growth rates."

South Africa's economy contracted in the second quarter this year, and although growth resumed in the third quarter, it was so weak that the pace of expansion is widely expected to fall short of 1.5% this year and fail to gather much momentum in 2016.

Several analysts said that S&P's decision suggested there was a strong likelihood the country would lose its hard-won investment-grade status in the medium term, and should serve as a wake-up call to policymakers in the government and the ANC.

But they were not upbeat about the prospects for meaningful change to boost sluggish economic growth.

"Given the poor prospects for the kind of reforms that would kick-start growth, South Africa's ratings are likely to remain under downward pressure," said Barclays Africa economist Peter Worthington.

Other analysts were more blunt. "I don't think that the shock will hit home and that the government will take this outlook change in the serious light in which it should be taken - this is an economy in trouble," said Lefika Securities economist Colen Garrow. "I think a year from now we can anticipate a downgrade to junk status."

Rand Merchant Bank currency strategist John Cairns said he expected a "huge negative reaction" in the rand, as the change in S&P's outlook was not anticipated by financial markets. The rand has been among the worst-performing emerging market currencies this year, weakening 24% to its R14.33/$ close on Friday.

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Close on the heels of the S&P announcement, Fitch Ratings downgraded its rating for South Africa to BBB-, the same level as S&P, but this had been expected and was seen as unlikely to rattle investors.

"We could lower the ratings if GDP growth does not improve in line with our current expectations, or if state-owned enterprises require higher government support than we currently expect," S&P said in its announcement. It forecasts growth of 1.4% this year, 1.6% next year, 2.1% in 2017, and 2.5% in 2018.

"We could also lower the ratings if external imbalances increase, or funding for South Africa's current account or fiscal deficits becomes less readily available."

S&P concluded that it could revise the outlook on South Africa's rating back to stable if it observed policy implementation that led to improved business confidence and increased private sector investment - which would contribute to higher growth.

South Africa has been hit by a barrage of negative economic data in recent weeks, with manufacturing activity plunging to a six-year low last month, according to the Barclays purchasing managers' index this week.

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