Fitch confirms Credit Rating as Junk, corrects Outlook to negative ... will Moody's follow?

26 Jul 2019 | Ray Mahlaka, Ralph M Ertner
South Africa Junk Status and negative Outlook

Today’s decision by Rating Agency Fitch to keep South Africa’s long-term foreign and local currency debt on BB+, the first notch of sub-investment grade (or junk status) did not come as a surprise given the recent fiscal circumstances. But on top of it, Fitch has downgraded the country’s outlook from stable to negative, citing concerns about the Tito Mboweni’s recently announced financial support of Eskom and a persistent low economic growth scratching the border to a technical recession.

All eyes are on whether Moody’s will take a more decisive view on the country’s deteriorating fiscal and economic performance and will follow suit in not to alienate itself through ill-advised ratings regarding South Africa.

South Africa’s Fiscal Trajectory

The seemingly never-ending government bailouts to bankrupt Eskom have not only vexed taxed-to-the-max South Africans but also credit rating agency Fitch Ratings. The rating agency, which followed S&P Global Ratings in placing South Africa’s creditworthiness to sub-investment grade (commonly known as junk status) in 2017, has taken another dim view of the country’s deteriorating fiscal and economic performance.

Although Fitch kept South Africa’s long-term foreign and local currency debt unchanged at BB+, the first notch of sub-investment grade, it has downgraded its outlook from stable to negative. Fitch cited two reasons for its bearish decision; the increased support for struggling state-owned enterprises (SOEs) such as Eskom, which will put the country’s worrying finances under more strain, and low economic growth.

Fitch said increased government spending on SOEs has increased the rating agency’s projections for South Africa’s debt-to-GDP. This week, finance minister Tito Mboweni said the state might have to increase borrowing to fund an extra ZAR 59bn in support for Eskom over the next two years. This will be on top of an already-promised insane and fiscally imprudent bailout of ZAR 230bn over the next ten years.

Eskom, which supplies more than 90% of the nation’s power, is facing a more than ZAR 500bn debt load while its ZAR 25bn revenue from the sale of electricity cannot even cover half (sic!) of its annual interest on this debt.

Failed ESKOM restructuring Promises

About the government’s long-mooted plan to restructure Eskom into three separate units comprising electricity generation, transmission, and distribution, Fitch said: “trade unions, fearing privatisation and job losses, are strongly opposed to these measures and Fitch believes significant progress will be challenging.”

The National Treasury said it is aware of the “strain and risk” posed Eskom. “A team of officials led by Directors-General of National Treasury and Public Enterprises has considered a number of options as a solution to Eskom’s debt challenge in order to ensure its sustainability, and the most viable of these will be communicated in due course.” Making matters worse is that economic growth for 2019 that has been revised down, making it difficult for the government to stabilise finances over the medium term. Economic growth for 2019 that has been downgraded by the SA Reserve Bank, which expects the economy to grow by 0.6% – lower than government’s 1.5% official forecast.

Fitch said low economic growth projections imply that the government will not reach its targeted tax revenue of R1.42-trillion for the 2019/2020 fiscal year and might record higher debt. Accordingly, Fitch expects South Africa’s debt burden to increase further to 68% of GDP by 2021/2022 (2018/2019: 57.3%), and not the 60% the government is budgeting for. It expects the 2021/2022 debt percentage to continue rising over the next few years, while the government expects it to decline from 2025/2026.

Will that influence Moody’s ?

The decision by Fitch to keep South Africa’s credit rating to junk status and downgrade its outlook will probably isolate Moody’s Investors Service and put more pressure on it to follow suit. After all, Moody’s is the only major ratings agency that has not downgraded South Africa to sub-investment grade.

Economists and market watchers have been battling to understand how Moody’s can hold a contrarian view relative to its credit rating peers, putting its credibility at risk. How is it possible that Moody’s continues to believe that South Africa is worthy of an investment-grade status?

Moody’s, like most South Africans, have given President Cyril Ramaphosa’s reform agenda the benefit of the doubt. The reform efforts it believes are positive include Ramaphosa’s $100-billion investment drive over the next five years, appointment of a new SARS boss Edward Kieswetter, rebuilding the credibility of institutions such as the National Prosecuting Authority and various concurrently-running commissions of inquiries that are exposing corruption in the state and private sector.

However, Moody’s made its displeasure known about the potential bailout to Eskom. Moody’s said the ZAR 59bn support for Eskom was “credit negative”, meaning it is so worrying that it might influence the rating agency’s decision to downgrade South Africa to junk status in its next credit rating review. Moody’s sovereign credit analyst for South Africa Lucie Villa said the government will struggle to absorb the latest financial support to the power utility. “The lack of a strategy to return Eskom to (a) more stable financial situation that would reduce the need for government support exacerbates the problem for the government,” said Villa.

Translating the most recent rating changes translates to the fact, that yesterday Souzth Africa’s economy stood at the edge of an abyss….today we moved a significant step forward!

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