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Standard & Poor’s downgrades South Africa

It was a gloomy Friday 13 June when Standard and Poor’s downgraded South Africa’s sovereign credit rating to BBB-, placing it in the same category as fellow BRICS countries, Brazil, India and Russia.

As expected, Standard & Poor’s (S&P) cut South Africa’s long-term foreign currency credit rating to BBB-, citing the weak economic growth outlook. This follows Fitch’s decision to lower the outlook on SA’s rating from stable to negative. S&P has a neutral outlook on the new rating.

S&P cut SA’s GDP growth forecast for 2014 to 1,9% from 2,7%. This is slightly better than Fitch’s forecast of 1,7%, but still represents a significant downgrade of the country’s growth prospects. Slower growth is expected to limit the government’s ability to raise tax revenues. S&P expressed concern over pressure from the next round of public sector wage negotiations. More specifically, S&P, like Fitch, has serious doubts whether government is committed to the necessary reforms to raise the country’s growth rate (particularly in terms of labour relations). However, both ratings agencies believe the policies of the new administration will be broadly in line with past policies (so now radical shift to the left).

Apart from the weak economic growth outlook, S&P also expressed concern over the high current account deficit, which has not narrowed significantly despite the weak economy. The protracted strike in the platinum sector (which hopefully appears to be near a resolution) and other sectors are also of major concern.

Because the issues raised by S&P were clearly flagged in December already, and widely known, the downgrade was not a surprise. Therefore short-term market reaction will probably be muted.

The longer-term outlook is more concerning as South Africa is now only one notch above ‘junk’ status. If we do not get growth going and make headway in closing the budget and current account deficits, a further downgrade is likely. This will probably put significant upward pressure on long-term bond yields and downward pressure on the currency as several foreign institutional investors will not be allowed to hold our bonds in terms of their mandates. Higher government bond yields will translate into higher borrowing costs for the private sector, potentially weakening growth and thus setting off a negative spiral.

Dave Mohr

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