TEXT - Fitch cuts South Africa's ratings
Jan 10 - Fitch Ratings has downgraded South Africa's Long-term foreign currency Issuer Default Rating (IDR) to 'BBB' from 'BBB+' and Long-term local currency IDR to 'BBB+' from 'A'. The Outlooks are Stable. The agency has also downgraded the Short-term IDR to 'F3' from 'F2' and the Country Ceiling to 'A-' from 'A'. Fitch has also downgraded the common Country Ceiling of the Common Monetary Area of South Africa, Lesotho ('BB-'), Namibia ('BBB-') and Swaziland (not rated) to 'A-' from 'A', in line with South Africa's Country Ceiling. RATING RATIONALE The downgrade of South Africa's sovereign ratings reflects the following key rating factors: - Economic growth performance and prospects have deteriorated, affecting the public finances and exacerbating social and political tensions. In the five years to 2012, GDP growth averaged 2.2% in South Africa (1.3% in per capita terms), compared with 4.7% for emerging markets as a whole. Weak growth reflects structural rigidities, declining competitiveness, policy uncertainty and labour unrest. - Public finances have weakened. Fitch estimates national government debt will have risen to 41% of GDP (around 43% including local authorities) at end-2012 from 27% at end-2008 and now slightly above the 'BBB' range median. In its 2012 Medium-Term Budget Policy Statement (MTBPS), the government announced slippage in its budget deficit consolidation plans out to 2014/15, which will result in a higher peak in the government debt ratio. - A trend decline in competitiveness, reflecting wage settlements above productivity and infrastructure constraints, contributed to a widening in the current account deficit to 6.5% of GDP in 2012 (Fitch estimate) from 3.4% of GDP in 2011. The country's net external debt position has also been trending up since 2006. - Social and political tensions have increased as subdued growth, coupled with rising corruption and worsening government effectiveness, have constrained the government's ability to improve living standards, reduce the 25.5% unemployment rate and redress historical inequalities as rapidly as the population demands. Protests over poor service delivery increased to record levels in 2012 and the economy has been beset by violent strikes that have affected growth and the current account. Nevertheless, South Africa's investment grade rating is underpinned by a generally sound banking system, a deep local bond market that allows the sovereign to borrow in its own currency (91% of the total) at long maturities (average 9.2 years, including T-bills) and a floating exchange rate and inflation-targeting regime that is an effective shock absorber. Furthermore, South Africa outscores the 'BBB' range median on all six of the World Bank's governance indicators as well as its measure of the business climate, and its income level is well above that of countries in the 'BB' range. RATING OUTLOOK - STABLE The rationale for the Stable Outlook is that it balances the upside and downside pressures. On the downside, on current policies, the country is on a path of gradual erosion of creditworthiness, particularly relative to 'BBB' range rating peers. Furthermore, current social tensions and presidential elections in 2014 mean there is potential for negative developments. However, South Africa's credit strengths limit the speed, magnitude and likelihood of a further potential downgrade over the typical two-year Outlook horizon. The African National Congress (ANC) conference in December elected Cyril Ramaphosa - a successful businessman, former mining union leader and ANC heavyweight - as deputy president and endorsed the National Development Plan (NDP), offering some hope of more effective leadership and a greater focus on structural reforms. It also rejected "strategic nationalisation" of mines, although it still resolved to "increase state ownership in strategic sectors where deemed appropriate" and failed to lift uncertainty over mining tax policy. The two-notch downgrade of South Africa's Long-term local currency IDR to 'BBB+' reduces the notching above its Long-term foreign currency IDR to one from two, more in line with most rating peers. It reflects the deterioration in the public finances and the fact that with around 91% of public debt denominated in local currency, the sovereign would gain little in debt relief in the event of a distress situation by treating foreign currency debt less favourably than local currency debt. Nevertheless, the one-notch uplift reflects the sovereign's greater capacity to finance itself in rand rather than in foreign currency owing to its powers of taxation, control of the domestic money supply through an independent monetary policy and its deep local bond market, which gives it the ability to issue sizeable volumes of local debt at long maturity. RATING SENSITIVITIES The main factors that could lead to negative rating action are: - Failure to generate faster GDP and employment growth, which is likely to require an acceleration of structural reforms - Material slippage against the MTBPS fiscal consolidation plans - A failure to improve competitiveness and narrow the CAD - Unorthodox policy measures that damage growth or a material increase in political instability The main factors that could lead to positive rating action are: - An acceleration of structural reforms that improve medium-term growth prospects, job creation and socio-economic conditions - A significant and sustained reduction in the budget and current account deficits KEY ASSUMPTIONS Fitch's fiscal projections are based on the assumption that the government will broadly stick to its budget deficit plans set out in the MTBPS. South Africa's exports are sensitive to the price of global commodities, which account for around half of exports. A severe and sustained fall in commodity prices would adversely affect the economy. The agency assumes that there is no wide-scale nationalisation of mines or other sectors of the economy. Such action would damage the investment climate and affect mining output. Fitch's current assumption for South Africa's medium-term growth potential is 3.5%, assuming some pick up in global growth.