Will Moody’s downgrade South Africa’s government issuer rating to B or below before 1 April 2016?

Let’s begin with Moody’s current rating and outlook for South Africa, as of today (February 11).

  • Rating: Baa2
  • Outlook: Stable

A Moody’s rating of Baa2 is a “medium grade, with some speculative elements and moderate credit risk”[1]. Other countries with a Baa2 rating at the moment include Italy, Colombia, the Philippines, and Spain[2]. So, roughly speaking, Baa2 is risky by the standards of Europe but fairly solid by the standards of the less developed (and/or formerly colonized) world (which includes South Africa).

Now, South Africa’s last change in rating from Moody’s took place on November 11, 2014 and was a downgrade from Baa1. According to Moody’s,

The key drivers of [South Africa’s 11-112014] rating downgrade are the following:

1) Poor medium-term growth prospects due to structural weaknesses, including ongoing energy shortages as well as rising interest rates, further deterioration in the investor climate and a less supportive capital market environment for countries such as South Africa that are highly dependent on external capital.

2) The prospect of further rises in the government debt-to-GDP ratio implied by the low-growth environment, which even strict compliance with the government spending ceiling and somewhat smaller fiscal deficits are unlikely to arrest in the near term.[3]

Why might South Africa be downgraded further by Moody’s?

South Africa’s ratings could be downgraded if the official commitment to fiscal consolidation and debt stabilization falters, or if the investment climate deteriorates further, imperiling the availability of external financing for the current account deficit.[4]

Obviously, the next question to ask is whether South Africa is meeting any of these conditions. But that question turns out to be a messy one to try to answer.

On the one hand, South Africa seemed to get off on the right foot, only to stumble soon thereafter. The nation’s leadership initially appeared to be trying to achieve fiscal consolidation[5], but the firing late last year of Finance Minister Nhlanhla Nene (which was part of a parade of “three finance ministers in two weeks”[6]) raised real questions about South Africa’s ability to achieve fiscal consolidation and debt stabilization. Indeed, Standards and Poor’s did downgrade South Africa last month[7].

But on the other hand, it’s not all bad news for South Africa. The current regime in South Africa seems to be taking the possibility of a downgrade pretty seriously[8], and President Jacob Zuma has been making the right kind of noises on this topic[9]. In general, South Africa does seem to be making an effort to allay concerns of this kind.

The controversy and market reaction to Zuma’s decision to fire Finance Minister Nhlanhla Nene on Dec. 9 may have served as a wake-up call to the authorities, Goolam Ballim, chief economist at Standard Bank, told reporters in Johannesburg.[10]

Yet note that GDP growth for this year is expected to be quite low – about 1%[11] or worse[12], And tough economic times in South Africa might make it very difficult for Zuma to deliver on his promises to the ratings agencies and other interested parties[13]. I remain open to the changing my mind (a lot!) about the possibility that South Africa will be downgraded before April 1. But currently, I’d say there’s about a 13% of this happening.

But our question is not whether Moody’s will downgrade South Africa’s rating before April 1. It’s whether Moody’s will downgrade South Africa’s rating to a B-grade before April 1. Just how bad is a B rating from Moody’s? Pretty bad. Here are a few of the states that have ratings between B1 and B3:

  • B1: Cyprus, Ethiopia
  • B2: Cambodia
  • B3: Ecuador, Pakistan, Egypt, Belarus

In order for South Africa to be downgraded to B or below, it would have to go through several other grades first: Baa3, Ba1, Ba2, and Ba3[14]. Of course, Moody’s could downgrade South Africa several grades at once, but that’s unusual. How unusual? It’s a really good question, and I had a hard time answering it. Individual firms and municipalities are sometimes subjected to massive downgrades. E.g., Moody’s downgraded Atlantic City six notches in 2015[15]. But I can’t find anything similar in the case of the debt of a sovereign nation. Downgrading South Africa to a B rating would be comparable to downgrading Italy (also currently rated Baa2) to the level of Ethiopia or Cambodia. And the odds of that happening can’t be much higher that 1%.

[1] https://en.wikipedia.org/wiki/List_of_countries_by_credit_rating#Moody.27s

[2] https://en.wikipedia.org/wiki/Moody%27s_Investors_Service

[3] https://www.moodys.com/research/Moodys-downgrades-South-Africa-to-Baa2-outlook-changed-to-stable–PR_312007

[4] https://www.moodys.com/research/Moodys-downgrades-South-Africa-to-Baa2-outlook-changed-to-stable–PR_312007

[5] http://www.focus-economics.com/countries/south-africa/news/politics/south-african-government-delivers-austere-2015-budget-aimed-at

[6]http://businesstech.co.za/news/government/112215/time-is-up-for-south-africa/

[7] http://www.bloomberg.com/news/articles/2016-01-18/south-africa-s-yield-premium-above-peer-average-for-first-time

[8] http://www.bloomberg.com/news/articles/2016-01-19/south-africa-vows-to-avoid-downgrade-to-junk-business-day-says

[9] http://www.timeslive.co.za/thetimes/2016/02/10/Zuma-must-stop-government-scoring-own-goals

[10] http://www.bloomberg.com/news/articles/2016-02-08/zuma-meets-south-african-ceos-as-investor-confidence-fades

[11] http://www.timeslive.co.za/thetimes/2016/02/10/Zuma-must-stop-government-scoring-own-goals

[12] http://mybroadband.co.za/news/general/154830-south-africas-economy-is-heading-to-zero.html

[13] http://www.nytimes.com/2016/02/12/world/africa/rivals-disrupt-jacob-zumas-speech-on-south-african-economy.html

[14] https://www.moodys.com/sites/products/AboutMoodysRatingsAttachments/MoodysRatingSymbolsandDefinitions.pdf

[15] http://articles.philly.com/2015-01-28/business/58513136_1_atlantic-city-borgata-downgrade

 

 

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