Paris, April 01, 2022 -- Moody's Investors Service ("Moody's") has today changed the outlook on the Government of South Africa to stable from negative. Moody's has affirmed South Africa's Ba2 long-term local and foreign currency issuer and senior unsecured debt ratings.
The key driver behind the decision to change the outlook to stable is the improved fiscal outlook that raises the likelihood of the government's debt burden stabilising over the medium term. While risks related to weak state-owned enterprises (SOEs) and social demands remain, they are consistent with a Ba2 rating. Indeed, over the last two fiscal years, the government has shown it was able to re-prioritise its spending while staying committed to fiscal consolidation, which Moody's expects will remain the case going forwards.
Meanwhile, the decision to affirm South Africa's ratings at Ba2 reflects the country's long-standing credit strengths, including a sound financial sector and external position, combined with persistent weaknesses primarily stemming from deep structural constraints on economic growth.
South Africa's country ceilings remain unchanged. The local currency country ceiling is positioned four notches above the sovereign rating at Baa1, reflecting predictable institutions and government actions as well as limited external imbalances and macroeconomic risks, but also the government's strong footprint on the economy. One notch below, the Baa2 foreign currency country ceiling reflects effective foreign exchange policy and a track record of maintaining an open capital account, indicating that the risk of restrictions on transfer and convertibility in times of stress remains contained.
RATINGS RATIONALE
RATIONALE FOR CHANGING THE OUTLOOK TO STABLE FROM NEGATIVE
South Africa's fiscal position has markedly recovered from the pandemic thanks to government's fiscal consolidation measures and positive external developments. As a result, it now looks likely that the government's debt-to-GDP ratio will stabilise around 80% (including guarantees to SOEs) over the medium term. This marks an improvement compared to Moody's previous projections of a long period of ever-rising debt-to-GDP.
High commodity prices have boosted profitability of companies in the mining sector, which contributed to a 58% increase in corporate income tax in fiscal 2021 (FY2021, ending 31 March 2022), or 2% of GDP higher than planned in the initial budget. At the same time, for the first time in many years, the government limited the growth of its wage bill to 1.6%, well below inflation. These were the two key factors behind the reduction in the government's primary deficit to 1.3% of GDP in FY2021 from 5.7% in FY2020 and narrower than Moody's previous forecast of 3.4%.
Moody's expects that the government will continue to pursue its fiscal consolidation strategy. In the meantime, tax compliance is likely to improve gradually as the South African Revenue Agency (SARS) rebuilds some of its intuitional capacity after a period of deterioration in terms of human capital and public standing. This would provide a degree of fiscal flexibility to manage risks associated with rising social demands amid inflationary pressures and a very high and rising unemployment rate (35% as of the third quarter of 2021). South Africa's SOE sector, which remains financially and operationally weak and relies on government support, is also a source of risk to Moody's expectation of a broadly stable government debt burden going forwards, but consistent with the Ba2 rating given the recent track record of fiscal consolidation.
RATIONALE FOR AFFIRMING THE Ba2 RATINGS
South Africa's Ba2 rating reflects a balance of long-standing credit strengths and weaknesses.
South Africa's financial sector is sound, posing limited risk to the government and providing it with a deep pool of domestic investors to borrow from. While the nexus between sovereigns and banks is an emerging concern, it is manageable with banks holding 17% of their assets in government debt. Meanwhile, external buffers against the risk of capital flight remain strong. A deep domestic financial sector buffers volatility created by high nonresident holdings of rand-denominated government debt, even though it does not remove risks related to currency volatility.
South Africa's large commodity export base has been supportive of its current account, which Moody's expects to remain in surplus this year. Moreover, the South African economy's sizeable external assets, which have exceeded external liabilities since 2015, provide additional buffers. Among these assets are South African Reserve Bank's foreign-exchange reserves, fully covering annual external debt payments . The central bank has a long-standing policy of refraining from intervening to prevent depreciation, thereby preserving buffers.
Set against these strengths, South Africa's growth remains structurally weak. Constraints emanating from a malfunctioning labour market and decaying infrastructure persist. The latter results in an energy gap and frequent power outages as well as other disruptions which are highly disruptive for the functioning of South Africa's energy-intensive economy. Moody's expects these constraints to remain and forecasts GDP growth at only about 1.5% in the medium term.
Very weak SOEs across a number of sectors, including electricity and transport, both contribute to weak growth and are affected by it, without any prospects of significant improvements in the foreseeable future.
In turn, structurally low growth and labour market rigidities prevent an improvement in living standards and a reduction in South Africa's vast inequalities, fuelling social risk.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
South Africa's ESG Credit Impact Score is highly negative (CIS-4), reflecting high exposure to social risks and moderately negative exposure to environment risks, combined with relatively low resilience as the weak public finances and relatively low-income levels constrain its capacity to respond to environmental and social shocks.
South Africa's moderately negative exposure to environmental risks, reflected in its E-3 issuer profile score, mainly relates to water and physical climate risks. As much as a quarter of the population is exposed to unsafe drinking water and significant parts of the population periodically face severe droughts. As climate change intensifies, water scarcity is likely to become increasingly constraining, reflected in Moody's assessment of moderately negative exposure to physical climate change.
Exposure to social risks is highly negative (S-4 issuer profile score), with a very high exposure to risks related to labour and income and high exposure to risks in health and safety. South Africa has one of the highest levels of income inequality, very high unemployment especially amongst the youth.
While governance is broadly in line with other sovereigns and does not pose particular risk (G-2 issuer profile), it is not strong enough to mitigate South Africa's exposure to social and environmental risks. Moreover, the government's high and rising debt burdens and low-income levels constrain the sovereign's financial capacity to respond to environmental and social risks.
GDP per capita (PPP basis, US$): 13,289 (2020 Actual) (also known as Per Capita Income)
Real GDP growth (% change): -6.4% (2020 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 3.1% (2020 Actual)
Gen. Gov. Financial Balance/GDP: -10% (2020 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: 2% (2020 Actual) (also known as External Balance)
External debt/GDP: 50.8
Economic resiliency: baa3
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 29 March 2022, a rating committee was called to discuss the rating of the South Africa, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has increased. The issuer's susceptibility to event risks has not materially changed.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
WHAT COULD CHANGE THE RATINGS UP
A rating upgrade would likely follow if South Africa demonstrated significant progresses towards alleviating structural constraints on growth, strengthening the prospects of a decline in government debt. Firm signs that the rehabilitation of the energy sector is underway would also be a key marker, pointing to higher growth and lower contingent liability risks from the SOEs sector.
WHAT COULD CHANGE THE RATINGS DOWN
A further erosion in South Africa's economic growth prospects and renewed deterioration in its fiscal strength would likely lead to a rating downgrade. Indications that the SOE sector required fiscal support well beyond Moody's current assumptions, thus inhibiting the government's fiscal consolidation efforts would also exert downward pressure on the ratings.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
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Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288235.
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Lucie Villa
VP - Senior Credit Officer
Sovereign Risk Group
Moody's France SAS
96 Boulevard Haussmann
Paris, 75008
France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's France SAS
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France
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
