SOUTH Africa’s sovereign rating is likely to be downgraded one notch after the 2014 election, probably in the second half of the year, financial research provider Nomura said in a report released on Thursday on the country’s prospects this year.
Rating agencies Standard & Poor’s and then Moody’s were the most likely to act in this regard, it said.
Nomura emerging-markets analyst Peter Attard Montalto said in the report that South Africa would face the same vulnerabilities this year that in the past had placed it on watch.
These included rising debt levels, a current account that was poorly funded and “sticky” around 5%-7% of gross domestic product (GDP), and the prospects of further labour market strife, in particular violent unrest.
“We see government debt levels rising to 49% by 2016 as a result of only a slow decline of the fiscal deficit from 4.4% of GDP in 2013 to 4% in 2014 and then only to 3.8% in 2015,” he said.
“Lower growth assumptions are also in play. As such we expect further (although smaller than previously) shifts up in the government’s debt profile at the budget in February.
“On fiscal policy, we think about 80% of the tax hikes that we expect after the election will be spent plugging the gap of yet larger public sector wage increases, as well as boosting the social wage in response to poor vote-take in the election. A decision not to pay down the deficit would be an alarm signal to the agencies.”
On the current account, Nomura forecast the full-year deficit to remain at about 5.8% of GDP, but as this would occur alongside equity outflows by foreigners and a stalling of bond inflows, it would worsen the funding of the balance of payments. This would be of concern to the credit rating agencies.
But Mr Attard Montalto said a downgrade was widely expected by the market and might therefore only have a short-lived effect.
He said he thought 2014 would be a volatile year for South African assets, though it was not likely to bring major upsets. Economic growth was expected to recover slowly and — based purely on domestic considerations — the risk of the rand reaching R11/$ or improving beyond R9/$ was low, he said.
While labour risk was likely to be higher, the defining issue would be political risk, Mr Attard Montalto said. This did not refer to the upcoming general election, which could be a fairly normal event, he said, but to the possibility of the National Union of Metalworkers of South Africa breaking away from the Congress of South African Trade Unions, and a break-up of the ruling tripartite alliance later.
Nevertheless, Mr Attard Montalto said the relative stability of South Africa’s vulnerabilities, risk and macro economy should stand it in good stead in the year ahead. This was an important consideration when looking at South African credit compared with Turkey, which had a less stable risk profile.
“With the exception of load-shedding risk and May rate hikes, we think the market is still broadly pricing in the (South African) risk outlook for 2014 and beyond on domestic idiosyncrasies,” he said.
Nomura has forecast growth of 2.5% for this year compared with the consensus of about 2.8%, after growth of 1.8% in 2013. Consumption expenditure is likely to stall as interest rate hikes begin and credit growth to households continues to slow. Growth in consumption of only 3.5% is forecast for the year, after 2.8% in 2013, while public sector investment growth is expected to grind to a halt as capacity constraints are reached. Private sector investment should recover to about 5.6%, from 2.8%.
Nomura has forecast a hike in interest rates in May as the beginning of a two percentage point cycle over 18 months as consumer price inflation rises on a weak rand.
On the labour front, it believed that “one of the biggest events of the year” would be a co-ordinated strike by the Association of Mineworkers and Construction Union in the Rustenburg platinum sector.
Industry was likely to continue to face electricity shortages, especially in the first quarter, while the recovery of the economy was likely to increase pressure throughout the year.
The biggest downside risk to growth was an earlier than expected hard landing of the Chinese economy, and “a faster crunch in consumption due to rate hikes and banking credit extension slowdowns”.
However, the risk of a hard landing in China was much lower than perceptions of it last year. China could grow at a slightly stronger rate of 7.4%, compared with forecasts of 6.9% through much of 2013, Nomura said.