Any economic risk assessment of South Africa would note a very noticeable deterioration in a wide range of key economic variables over the past nine years. These include a substantial rise in government debt, including a dramatic increase in financial support provided by government to the major state-owned enterprises (SOEs), a sharp slowdown in economic growth to an average of less than 1% over the past four years, and a further rise in the country's already-high level of unemployment.
Under these circumstances, both Standard and Poor's and Fitch Ratings understandably opted to lower SA's international credit rating below investment grade in 2017.
While Moody's Investors Service acknowledges the deterioration in a wide range of key economic variables, it has maintained SA's international credit rating above investment grade in recent years.
Differences in methodology help to explain this divergence. It also seems clear that Moody's places a lot of emphasis on assessing the portion of government debt that is owed to foreigners. This is because the less foreign debt a government incurs, the more it is able to control the circumstances affecting its ability to service the debt. In contrast, when a large portion of a government's debt is owed to foreigners, its ability to manage the cost of servicing that debt is largely outside its control. That is especially the case if the currency starts to weaken, which normally happens once a country starts to incur financial difficulties.
Stated differently, if two countries have exactly the same level of government debt, and their other economic conditions are fairly similar, then both should attract the same international credit rating. However, if one of them has a significantly larger portion of its government debt denoted in foreign currencies, then its credit assessment will probably be markedly weaker than that of the country whose government owes most of its debt to domestic investors. Governments are much more likely to find a way to repay their domestic debt than they are able to source foreign funding to repay foreign debt.
According to SA's Minister of Finance, in 2019/2020 government debt is projected to rise to 56.2% of GDP, which is well above the 26% of GDP recorded in 2008/09, and a key reason why Fitch Ratings and Standard & Poor's cut the credit rating below investment grade. However, the proportion of government debt owed to foreigners is projected at a much more modest 5.5% of GDP in 2019/2020, which is not that much higher than the 4% of GDP that prevailed in 2008/2009.
This means that while SA's total level of government debt is relatively high and has risen dramatically in recent years, the government's level of foreign debt is modest and well below the average for many emerging economies, including some emerging economies with a credit rating higher than SA's.
This analysis can be expanded to include the foreign debt owed by the private sector, including corporates and households. In April 2019, SA's total debt (including households, non-financial corporates, government and the financial sector) amounted to a fairly substantial 153% of GDP. However, the foreign component of this debt totalled a much more modest 33.9% of GDP. While this is not insignificant, it is well below the level of foreign debt incurred by many other emerging economies and is also fairly manageable, given the foreign earnings of the country.
Overall, there is little doubt that SA's fiscal position has weakened significantly since 2009, and that the associated credit risks have increased materially. However, in the midst of this deterioration, there are some important positives. This, together with a concerted effort on the part of the newly-appointed Cabinet to improve the country's economic performance, could provide a vital uplift to investor confidence.
Kevin Lings will be presenting at the Allan Gray Investment Summit in Johannesburg and Cape Town in July 2019. www.investmentsummit.co.za
Book your seat at the Allan Gray Investment Summit taking place on 22 July at the Cape Town International Convention Centre and 23 July at the Sandton Convention Centre.