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Update on South Africa – Q3 2016

Tuesday 20th September 2016

Factors affecting South Africa like the recent political infighting, paralysis and dragging feet with the urgent and much needed transformation of SA parastatals, can possibly cost the country dearly in December. Moody’s Investor Service, one of the three biggest credit ratings agencies in the world, warns in its quarterly overview that South Africa’s continued guarantees to loss-making parastatals, for example South African Airways, indicate the avoidance of difficult and contentious structural reforms. This comes shortly after the Treasury (led by finance minister Pravin Gordhan) gave guarantees worth R5 billion to SAA to keep it afloat. Nonetheless Moody’s state that it thinks political infighting remains the biggest risk to South Africa’s credit rating, even though it is moderate but persistently on the increase.

External to South Africa’s politically motivated risk factors but inherently linked to the perception of risk is the fund flows from foreign investors who are hunting for yield, which they still find in the ZAR. This is however heavily influenced by the outlook for anticipated US rate rises, as no-one wants to be caught holding a devaluing ZAR currency if US rates are set to rise. But the US rate rise in itself has been the subject of speculation, even among Fed officials themselves it seem.  SA’s rate of inflation is still much higher than that of most developed nations and can rise further given exchange rate shocks that can happen from time to time initiated by capital flight from SA for example of the US were to suddenly raise their interest rates on the back of a Trump election victory. SA has a well-developed financial sector and technologically advanced stock exchange which enable foreign investment into the country at the push of a button. Problem is this enables the outward flight of capital just as easily, for instance if Janet Yellen announces a bigger than expected interest rate increase and the market is caught by surprise.

This week all eyes will be focused on the American Federal Reserve (the Federal Open Market Committee (FOMC) and its 12 members, seven from the Board of Governors and five of the Federal Reserve Bank presidents). In addition to the FOMC, which is widely expected to keep rates on hold, the Bank of Japan (BOJ) is seen as easing their policy slightly, but we will only know when both the FOMC and BOJ concludes their respective meetings on Wednesday. More importantly than what they do is what is said following the meetings and their expectations.

Markets can show signs of volatility in lieu of the fact that post meeting comments are being made this week. The ZAR/USD closed this Friday (16/9) at R14.18 to the dollar versus the previous Friday’s R14.41 to the dollar. All eyes will be on FOMC commentary whether a December rate hike in implied or suggested as the markets are pricing in a 12-15% chance of a Fed rate hike following the conclusion of this meeting. Hawkish sentiment pertaining to a possible December rate hike however can steer market volatility into overdrive. This will not support ZAR and it can weaken on the back of dollar strength, however it can also be supported by BOJ if they lower their interest rates. This will take ZAR to stronger levels. America and Japan’s rate decisions will be announced on Wednesday. The South African Reserve bank (SARB) will make its interest rate decision known on Thursday, which is widely expected to remain unchanged. Also this weeks in the interest rate decision space is other African countries by name of Ghana, Kenya and Nigeria, all announcing their interest rate decisions this week.

The SARB has increased its repo rate by 125 basis points (1.25%) since July 2015. Growth remains weak but inflation improved (6% year-on-year in July ’16 following a 6.3% rise in the previous period), so all 15 economists which took part in a Bloomberg survey expects the rate to remain unchanged on Thursday.

Moody’s is currently in South Africa for its annual conference and it is expected that deputy president Cyril Ramaphosa together with Pravin Gordhan be meeting with the credit ratings agency. Early next month a South African delegation headed by Gordhan and Lesetja Kganyago, president of the Reserve Bank, will head to the USA to ease any concerns investors that the USA might have and to market SA as a good country for them to invest in. Growth has picked up in SA since the last ratings were carried out and there is even a trade surplus on the current account of R12.5 billion, from a deficit of R22 billion in the first six months of this year. The big challenge will be the SA parastatals, with their financial stability at stake, dependent on repeated bailouts by the SA government fiscus. To name a few companies under the spotlight of Moody’s review: Escom (Electricity Supply Company), Sanral (South African National Roads Agency), DBSA Development Bank of South Africa and two other state owned entities as well.

Their individual ratings have already been put under close watch for a possible future downgrade. Any further attacks on our finance minister, Pravin Gordhan, will push the country over the “cliff edge”. If there are any meddling in the finance minister’s attempts to restructure or to limit his power in the process of restructuring the troubled enterprises this will be a sign to the credit ratings agencies to assume a negative stance on South Africa’s credit rating. Brazil is chilling reminder of how the recent impeachment of former president Rousseff lead to a popular uprising against her and her government. Unrelated to this Moody’s kept the credit rating of two of SA’s gold producers, AngloGold Ashanti(Baa3) and Gold Fields(Baa1), unchanged and changed the outlook form stable to positive. This shows that they have faith in these producers and that it is not yet too late for the government to at least try and tackle the problems of the numerous parastatals under their control.