South Africa escapes junk status – for now

In late November and early December, two of the major rating agencies announced their decisions on South Africa’s status for the coming six months. Fitch made its announcement first, revising the outlooks on South Africa’s credit rating to negative from stable, while affirming the long-term foreign and local currency issuer default ratings (IDRs) at BBB-. The issue ratings on South Africa’s senior unsecured long-term foreign and local currency bonds have also been affirmed at BBB-. The country ceiling was affirmed at BBB. In December, S&P Global Ratings lowered the long-term local currency rating on South Africa to BBB from BBB+ and affirmed the A-2 short-term local currency ratings. It affirmed the long- and short-term foreign currency ratings at BBB-/A-3. The outlook on the long-term ratings remains negative. At the same time, S&P affirmed the zaAAA/zaA-1 South Africa national scale ratings. hide Speaking to Bloomberg, South Africa’s Treasury director-general Lungisa Fuzile reacted quickly, saying: “The fact that we have been able to preserve our investment-grade rating even in the face of all the global and domestic challenges is good enough for now. This buys us more time. I really believe we are on the brink of turning things around.” Meanwhile, Christie Viljoen, an economist at KPMG LLP in Cape Town, told Bloomberg that, while the country had dodged a bullet, the negative outlook meant the rating move would be into junk territory. That would probably increase borrowing costs, making it more difficult for the government to meet its fiscal targets and rein in debt, reported Bloomberg. “They are sending the same signal as what we have had from S&P since late last year, that the next move is down to a place where you don’t want to be,” Mr Viljoen said. “We need an effort right from the top of government to get this economy going.” Fitch said the revision of the outlooks on South Africa’s long-term IDRs to negative reflects the fact that political risks to standards of governance and policymaking have increased and will remain high, at least until the electoral conference of the African National Congress (ANC) in December 2017, negatively affecting macroeconomic performance. It warned: “The in-fighting within the ANC and the government is likely to continue over the next year. In Fitch’s view, this will distract policymakers and lead to mixed messages that will continue to undermine the investment climate, thereby constraining GDP growth. “The South African economy may have started recovering from a series of shocks, but business confidence remains depressed and investment has continued to contract. We expect only modest GDP growth of 1.3% in 2017 and 2.1% in 2018, although this is an improvement from 0.5% in 2016. The economy had been hit in 2015 and 2016 by electricity shortages, the worst drought in decades, a sharp fall in international prices for some of South Africa’s main mining commodities, and rising policy uncertainty.” Fitch believes the net international investment position turned positive in 2015, at 13% of GDP, for the first time since at least 1990, although this was largely due to the depreciation of the rand. It also said: “Despite weak macroeconomic conditions, the banking sector remains a rating strength. The total capital adequacy ratio of the system increased to 15.5% in September from 14.2% at end-2015. However, total domestic credit growth slowed to 7.5% in August, the lowest since 2014 and only moderately above inflation. Non-performing loans stood at 3.2% of total assets. Inflation has risen back above the upper limit of the inflation target range of 3%-6% of the South African Reserve Bank (SARB) but is likely to ease, so that SARB is unlikely to further raise its interest rates beyond the current level of 7%.” S&P warned: “South Africa’s pace of economic growth remains a ratings weakness. It continues to be negative on a per capita GDP basis. While the government has identified important reforms and supply bottlenecks in South Africa’s highly concentrated economy, delivery has been piecemeal, in our opinion. “The country’s longstanding skills shortage and adverse terms of trade also explain poor growth outcomes, as does the corporate sector’s current preference to delay private investment, despite high margins and large cash positions.” It added: “While we believe the electricity sector has improved – with no load shedding since winter 2015 reflecting new capacity and lower demand – delivery on labour and mining sector reforms and other planned growth-enhancing measures continues to be slow. We think the government will soon enact the Mining and Petroleum Resources and Development Amendment Bill, which parliament recently passed into law. However, the mining charter is still under discussion and may drag over the next year.” Back in October, S&P assessed the insurance industry and country risk as moderate in the South African property and casualty (P&C) sector. The agency said: “This reflects our view of country risk as moderate and industry risk as intermediate. “Our expectation is that the P&C insurance sector in South Africa will show constrained real premium growth in the next two years as a result of weak economic growth prospects.” Neil Gosrani, director, insurance ratings, at S&P, told Commercial Risk Africa that the insurance sector will continue to look relatively safe. “It is almost around the macro environmental risks instead,” he said. The S&P report had echoed that. It concluded: “We view the balance of industry factors as a relative strength, reflecting our view of the P&C insurance sector’s earnings as positive (based on our forecast of industry return on equity), barriers to entry as modest, and the regulatory framework as supportive. “Our assessment of moderate country risk reflects the economic risks stemming from weak economic growth, relative to that of peers in similar wealth categories, wide income disparities and infrastructure gaps, modest financial system risk and an acceptable rule of law. “South Africa is one of the largest economies in Sub Saharan Africa and has a well developed insurance market. That said, the country’s GDP per capita has deteriorated in recent years, which is likely to affect the insurance market’s growth prospects.” Mr Gosrani said: “The thing to be aware of is that one of the factors we look at in a rating is the quality of assets that a company holds. If we see a deterioration of the quality of assets, that can budge the rating lower. “A sovereign rating does not present a firm cap [for insurance companies], which is in contrast to bank ratings. The difference comes down to how capital works,” he explained. “In banking, the issue is in liquidity and a day-one impact. With an insurer, they need capital to pay claims if they come through. So, for a bank the risk is upfront, while for an insurer the risk is longer term.” Mr Gosrani was speaking in the wake of a day-long event held by S&P in Johannesburg. Jonathan Dixon, deputy CEO insurance, Financial Services Board, told the delegates he was concerned by the inertia in the market. “There is an element of inertia on the part of the industry – that is a big risk and they need to adapt and change to thrive,” reported Mr Gosrani. Repeating the key messages from Mr Dixon, he said the regulator recognises the existing outsource model has benefits for insurers but it also carries “inherent weaknesses” and these will need to be addressed going forward. Going forward, said the regulator, there will be greater emphasis on transparency and governance. The move towards Sam regulations is ongoing and is tied up with the need to drive South Africa forward in its international obligations. The delegates also heard from Terry Ray, CEO, Scor Africa, who discussed the arrival of new entrants, saying there was an expectation more of the international reinsurance companies might open up in South Africa, as a result of the changing regulations on establishing a reinsurer in the country. The figure being touted was half a dozen, but neither Mr Ray or Mr Gosrani was ready to speculate on exactly who that might be. The main thing, said Mr Gosrani, is that South Africa remains an attractive location for businesses, which can still see opportunities for a solid return on equity. “We would expect that for a market like South Africa. It has a well developed insurance market but is a developing market,” said Mr Gosrani, which he explained means there are still plenty of growth opportunities for the future.

South Africa escapes junk status – for now

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