Eskom, SAA helps to push SA towards junk cliff - economist

Carin Smith

Cape Town - South Africa is propably heading towards a junk status due to policy makers not realising the danger and acting beforehand, according to emerging markets economist Peter Attard Montalto of Nomura.

He reacted to ratings agency S&P revising its outlook for SA to negative on Friday.

"We believe a downgrade to junk is still on the way. We see growth risks to the downside, and a lack of political space for structural reforms, and a better fiscal picture in the short run eventually coming up against political constraints in the medium run," said Montalto.

"On both structural reforms and fiscal, there is a realisation for a need for reform and consolidation at the highest levels of government and the ANC. These same people understand the risk of downgrades and sub-investment grade. However, we do not believe they understand - even after the S&P revision - the need for timely, urgent prioritisation of consolidation and reform."

In his view political balancing and rent extraction is just too important for now.

"A massive domestic risk shock and accompanying market shock will be needed to shift this. That probably will only come with a downgrade to junk," said Montalto.

Nomura now estimates SA could face junk status from S&P by 2017 or even by the second half of 2016 if downside growth risks are realised. Ratings agency Moody’s, however, has further to shift, so the double-junk scenario may still remain a 2018 story barring an earlier bigger shock, according to Montalto.

The drag that support for parastatals like Eskom and SAA bring for South Africa's rating, is reflected in the latest rating by S&P, added Montalto.

"S&P's revised outlook on SA to negative, while affirming its BBB-rating, shows that the ratings agency now sees the risk that parastatals support puts a greater drag on the fiscus," he explained.

"The negative take here is important and reflects the fact that whilst Eskom improvements have occurred, medium-term financial - tariff and procurement - risks remain. Equally there is the SAA story, which can deteriorate rapidly next year."

Although S&P's outlook revision was a bit of a surprise to Nomura, it also reflects, in its view, the fact that growth in the country may surprise to the downside. Structural reforms are not occurring to boost growth and improve business confidence.

"Reading between the lines, the implication is that S&P sees the political and institutional space at risk for reform potential and for the National Treasury to be able to manage contingent liability and parastatal risk as shrinking or at risk of shrinking," said Montalto.

Montalto pointed out that S&P still places a lot of faith and benefit of the doubt on Treasury to run conservative fiscal policy.

"The risk is that this core conservatism - that is what Treasury has control over - gets largely overshadowed by the wider political issues and constraints on the public sector that it has no control over," said Montalto.

"All this said, credit still trades as if average rates are around BBB- (negative) and equally a strong backstop from locals having to buy bonds under the capital control framework remains."

A big repricing on credit, therefore, seems unlikely, in Montalto's view, but means credit markets may move more in sync with the political space and "parastatal stories".