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Rating Action:

Moody's changes South Africa's rating outlook to negative from stable; affirms Baa2 rating

15 Dec 2015

New York, December 15, 2015 -- Moody's Investors Service (Moody's) has today affirmed South Africa's Baa2 government issuer ratings and changed the rating outlook to negative from stable.

The decision to change the outlook to negative from stable on South Africa's Baa2 rating rests on two main drivers:

1. Increased probability that growth will remain low for a prolonged period of time due to the structural challenges facing the mining industry and other sectors of the economy; and,

2. Rising risk of fiscal slippages in the face of both slower growth and increasing political pressures.

At the same time, Moody's affirmed the government's Baa2 rating because of the country's track record of sound macroeconomic policies. Credit metrics are still roughly in line with similarly rated peers in terms of both quantitative and qualitative comparisons and the external position is manageable, despite a steep depreciation of the exchange rate and heightened risk aversion to emerging market exposure in global capital markets. Although growth has continually disappointed in recent years due to a combination of domestic and external circumstances, spending restraint and the buoyancy of fiscal revenues to date has led to only marginal deviations for budget deficits and debt. At the same time, moderate foreign currency debt exposure has limited the impact of the depreciation of the rand and capital inflows have been sufficient to finance the shrinking current account deficit.

In a related action, Moody's also affirmed the Baa2 rating of the ZAR Sovereign Capital Fund Propriety Limited, a special purpose vehicle whose debt issuance is ultimately the obligation of the South African government. The rating outlook changed to negative from stable.

Moody's also made no changes to South Africa's local or foreign country ceilings, which remain at A1 for local currency debt and deposits, A2/P-1 for foreign currency debt and Baa2/P-2 for foreign currency bank deposits.

RATIONALE FOR ASSIGNING A NEGATIVE OUTLOOK

FIRST DRIVER -- INCREASED PROBABILITY OF PERSISTENT SUB-PAR GROWTH

The first driver for changing South Africa's rating outlook to negative is the economy's increasingly weak growth outlook, which Moody's now believes is likely to be sustained as a result of persistent structural challenges. Its latest growth projections now assume just 1.4% growth in 2015 and 2016, compared to forecasts averaging double that pace a year ago, and project that growth will not reach 3% again before 2020. The weak external position, and in particular the implications of the collapse in the rand for inflation and interest rates, pose additional downside risks to growth.

Moody's identified a number of negative pressures in November 2014 when South Africa's rating was downgraded to its current Baa2 level, including the protracted delay in overcoming the country's electricity shortages, slowing growth in China, the downturn in commodity prices and the long-anticipated hike in US interest rates. The intervening period has demonstrated the South African economy's vulnerability to these pressures, which are likely to be sustained.

In particular, persistently low commodity prices will suppress earnings already squeezed by higher energy and labor costs in South Africa's mining industry, an important employer and the source of nearly one-third of the country's merchandise export receipts. As such, the commodity price decline adds a structural demand component to cost considerations already contributing to the permanent closure of many mines, with negative implications for consumption over the near term and for the productive capacity of the economy over the longer term. Moreover, output in agriculture and other water-dependent sectors has been severely hit by southern Africa's worst drought in 34 years.

South Africa's challenging investment climate restricts its long-term economic growth potential, which in Moody's opinion derives principally from shortfalls in both human and physical infrastructure resources as well as political/policy uncertainty. Skills shortages are the result of the inadequacies of the education system despite the broadening of public schooling to all segments of society and substantial budget outlays year after year in the past two decades. Other important aspects constraining growth potential are the rigid regulatory framework governing the labor market and relatively militant unions in key occupations, such as mining and the public sector. The combination of these various factors has kept the labor force participation rate below 60%, unemployment for the broader population at 25% and youth unemployment at 50%.

As to physical infrastructure, concerted public sector efforts have made significant progress in the expansion of both transport and basic utilities, as well as housing, although much more remains to be done in both urban and rural areas. However, prolonged delays in constructing new power generation and transit facilities explain why South Africa was unable to boost production to take advantage of the commodity price boom in the 2000s and also why growth remains severely constrained at present. Moody's notes, however, that electricity availability has been steadier in the second half of 2015 thanks to improved management of plant maintenance schedules, the activation of one unit of the new Medupi power station and the inclusion of new renewables capacity into the grid. Still, the new plants are not expected to be fully operational for two-three more years, and until then, it will take time for the recent improvements in the electricity supply-demand balance to begin to filter into spending and investment decisions.

SECOND DRIVER -- RISING RISK OF FISCAL SLIPPAGES IN THE FACE OF POLITICAL PRESSURES AND SLOW GROWTH

The second driver for the negative outlook is the risk that public spending restraint will weaken in the face of political pressures while revenues underperform in the context of a prolonged period of sub-par growth. The South African government faces persistent fiscal pressures as a consequence of still-prevalent unemployment and poverty. The authorities' ability to stabilize the government's debt ratios is subject to very significant challenges that go beyond the consequences of low growth for tax revenue.

Even without considering the cost of expensive new programs that government is eventually committed to pursuing, such as nuclear power development or National Health Insurance, Moody's says that political pressures were growing, calling into question the government's continued ability to maintain spending restraint. Earlier this year, government reached a wage agreement with civil servants that resulted in much higher wage increases than the 6% that the National Treasury had budgeted, with 8%-10% increases in the first year and inflation plus 1% for the final years of the contract. The wage increases eroded most of the buffers built into the medium-term budget ceilings for the period 2015/16-2017/18, such that any new primary spending allotments would need to be accommodated by reallocations from other areas.

One additional source of political pressure is the upcoming local elections in May 2016. Moody's notes that while the South African government is not known for ramping up spending ahead of elections because of its disciplined fiscal framework, the potential for losses of several important cities represents a deeper challenge than the ANC has faced since the democratic transition in 1994.

RATIONALE FOR AFFIRMING SOUTH AFRICA'S Baa2 RATING

In spite of concerted budgetary pressures and slower than expected growth, Moody's has affirmed South Africa's Baa2 government debt rating because of the country's established track record of sound macro-economic policies. Credit metrics are still roughly in line with similarly rated peers and the external position is manageable, despite a steep depreciation of the exchange rate and heightened risk aversion to emerging market exposure in global capital markets. The news that Pravin Gordhan, the finance minister during President Zuma's first term in 2009-14, has again taken over as finance minister supports the contention that spending discipline will be maintained. Mr. Gordhan was in charge of the National Treasury when the Medium Term Expenditure framework was converted into strict spending ceilings in 2012. Both the Presidency's statement when nominating him and his own initial statement following his swearing in explicitly commit to the importance of the spending ceilings.

Although the economic slowdown is greater than forecast a year ago, Moody's baseline scenario is that the impact on the government's key credit metrics will be relatively modest relative to its expectations in November 2014. The rating agency now assumes that the gross government debt to GDP ratio will stabilize at around 50%. Although growth has continually disappointed in recent years due to a combination of domestic and external circumstances, spending restraint and the buoyancy of fiscal revenues to date has led to only marginal deviations for budget deficits and debt. At the same time, moderate foreign currency debt exposure has limited the impact of the depreciation of the rand and capital inflows have been sufficient to finance the shrinking current account deficit.

Moody's also takes into account that South Africa's government's faces lower refinancing risk than its Baa peers due to its elongated (14.3-year average maturity) debt structure, the low share of foreign currency-denominated debt, and its ready access to domestic and external debt markets. The government has a similar debt burden, better debt affordability metrics and lower share of foreign currency debt exposure than several other of its emerging market Baa-rated peers, such as Colombia and Uruguay.

WHAT COULD CHANGE THE RATING UP/DOWN

Moody's could revise the rating outlook to stable if policymakers were able to maintain spending restraint despite the accumulation of spending pressures. The rating could be upgraded if planned structural reforms, such as embodied in the National Development Plan, were implemented and were successful in raising the economy's potential growth rate, thereby reducing both its exposure to external shocks and its stubbornly high unemployment rate. Over the longer term, reforms resulting in higher domestic savings and investment rates and sustainable, stronger growth, alongside continued restraint in public debt accumulation and the ongoing implementation of the macro- and micro-level reforms embedded in the NDP would also be credit positive.

Alternatively, evidence of further shocks to growth and/or lower commitment to fiscal restraint implying a higher than expected rise in the government's debt burden could lead to a downgrade, particularly if that reduced South Africa's access to the capital flows needed to finance the current account deficit. South Africa's rating could be downgraded if the country's commitment to fiscal discipline and debt stabilization were to falter, as evidenced by an explicit upward shift in the spending ceilings or if budget commitments for new programs were to threaten those ceilings implicitly. Further deterioration in the investment climate would place downward pressure on the rating if it undermined growth and/or the availability of external financing for the current account deficit. More generally, indications that the slowdown in growth will be even deeper and more protracted than currently expected would be negative for the rating.

Outlook Actions:

..Issuer: South Africa, Government of

....Outlook, Changed To Negative From Stable

..Issuer: ZAR Sovereign Capital Fund Propriety Limited

....Outlook, Changed To Negative From Stable

Affirmations:

..Issuer: South Africa, Government of

.... Issuer Rating (Foreign Currency), Affirmed Baa2

.... Issuer Rating (Local Currency), Affirmed Baa2

....Senior Unsecured Medium-Term Note Program (Foreign Currency), Affirmed (P)P-2

....Senior Unsecured Medium-Term Note Program (Foreign Currency), Affirmed (P)Baa2

....Senior Unsecured Regular Bond/Debenture (Local Currency) Affirmed Baa2

....Senior Unsecured Regular Bond/Debenture (Foreign Currency) Affirmed Baa2

....Senior Unsecured Shelf (Foreign Currency), Affirmed (P)Baa2

..Issuer: ZAR Sovereign Capital Fund Propriety Limited

....Senior Unsecured Regular Bond/Debenture (Foreign Currency) Jun 24, 2020, Affirmed Baa2

GDP per capita (PPP basis, US$): 13,094 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 1.5% (2014 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 5.3% (2014 Actual)

Gen. Gov. Financial Balance/GDP: -3.2% (2014 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -5.4% (2014 Actual) (also known as External Balance)

External debt/GDP: 41.5% (2014 Actual)

Level of economic development: High level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 11 December 2015, 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 materially decreased. The issuer's fiscal or financial strength, including its debt profile, has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy 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 rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt 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 rating action on the support provider and in relation to each particular 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.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Kristin Lindow
Senior Vice President
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's changes South Africa's rating outlook to negative from stable; affirms Baa2 rating
No Related Data.
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