South Africa’s credit rating surprise

S&P Global unexpectedly lowered its outlook on South Africa’s junk-rated debt from positive to stable due to the country’s poor economic growth and increased load-shedding.

The agency said reforms to address infrastructure shortfalls and improve governance and performance at state-owned enterprises (SOEs) have been slow.

These failures weigh on the country’s growth, while the country’s crumbling SOEs pose a risk to South Africa’s fiscal and debt position.

It raises the question of what it means for South Africa and its effect on the local economy.

Credit ratings express the rating agency’s opinion on the credit quality of the issuer’s debt.

Creditworthiness speaks to the borrower’s ability to fulfill its financial obligations, which are the timely repayment of both the capital portion and interest portion of its debt.

S&P grades a country’s credit using quantitative models in combination with qualitative information.

A few of the most important considerations are:

• The issuer’s willingness and ability to repay its debt in a timely manner
• Fiscal and monetary stability.
• Economic performance.
• Institutional effectiveness.

S&P then delivers an opinion on government debt in the form of a credit rating. Credit ratings on S&P’s rating chart vary from an AAA rating to a D rating.

AAA ratings are the highest quality debt in the market and are most commonly associated with U.S. treasury bonds.

In 2020, S&P downgraded South African debt to a BB- credit rating with a stable future outlook. It placed South African debt on the brink of becoming very speculative.

There was optimism last year when S&P lifted its outlook for South Africa to positive, giving investors hope that the credit rating would improve with time.

This hope was short-lived. S&P cut South Africa’s outlook to stable because of deteriorating public infrastructure, load-shedding, and poor economic growth.

A credit rating is an important component that affects the government’s budget as higher credit risk causes an increase in the financing costs of government debt.

South Africa’s cost of government debt was the fastest growing line item in finance minister Enoch Godongwana’s latest budget speech.

A further deterioration in South Africa’s credit rating could put additional pressure on the cost of debt.

Many foreign institutional investors are also prohibited by their mandates from investing in bonds below a certain credit rating.

As the South African credit rating deteriorates, it puts immense pressure on foreign investment in the country.

Since 2012, S&P has significantly decreased South Africa’s credit rating. It went from nearly high grade to speculative.

The effect of being downgraded to junk status in 2017 can clearly be seen in the declining level of foreign investment in government bonds.