SA's credit rating under pressure

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IOL Business/ Annabel Bishop - May 20th, 10:07

The rand weakened as foreigners sold off R400 million in equities and R799m in bonds last week, driving the rand from R9.15 to the dollar at the start of the week to almost R9.40 on Friday. International markets are very sensitive to any labour disruptions in the mining industry given the tragedy at Marikana last year. 

The labour problems in South Africa’s mining sector have increased operational costs, as has substantial government resistance to proposed retrenchments in the face of rising costs, not least wages given the low degree of mechanisation and high level of labour intensity compared with international mining models.

The inability to price risk for South African corporates has risen and is not limited to the mines as labour rigidities prevail, from difficulties to hire and fire to very low levels of flexibility in wage determination and low productivity levels compared with pay levels internationally.

Indeed, the World Economic Forum ranked South Africa as the worst country in the world in terms of co-operation in labour-employer relations.

The rating agencies have raised concern over the labour unrest in mining and on social unrest generally in the country, given the inflexible labour market, which reduces the chance of employment.

South Africa is two notches away from speculative grade, on the Fitch and Standard & Poor’s rating of BBB. A further downgrade would place it at triple B minus, only a notch away from BB+, the highest speculative grade ranking. Foreign investors, who hold a third of South Africa’s bonds and equities, sold off government bonds on the strike news on fears it could increase the odds of a rating downgrade.

This has also weakened the rand, as investors are very wary of South Africa dropping to the bottom of the investment grade ratings. Unfortunately not only are we likely to see more of the same in the months and years ahead, in terms of the dysfunctionality of the labour market, where strikers are rewarded with more pay without concomitant rises in productivity, but the minister of mineral resources has threatened mining companies with loss of their mining licences in the face of proposed retrenchments.

State control

This high level of state control and loss of free market functioning means the labour market will fracture further. While South Africa is in the process of quite correctly addressing the apartheid legacy and the need for a decent wage, estimated at R6 500 a month, many of the strikers tend to earn substantially more than this.

We have raised the probability of our down case (rating downgrade) scenario, to 40 percent from 30 percent, due to the harm strike action can potentially cause to the economy. The down case scenario includes domestic work stoppages (fiscal slippage, rating downgrades) resulting in economic slowdown and so widening of the current account and trade deficit ratios to gross domestic product (GDP).

The down case scenario of a drop in GDP growth would also result in widening of the fiscal deficit and fiscal debt ratios, reducing slightly the perceived chance of the government meeting its repayments.

The expected case scenario, which fell to 45 percent from 50 percent, is one of economic growth of 3 percent this year rising to 5 percent on the back of the improved global economy. We expect the global economy to reach trend growth in 2016, raising South Africa’s economic growth. Improved exports would reduce the current account deficit, aiding the currency.

The market is factoring in the possibility of a 25 basis point cut in the repo rate by the end of the year with almost 100 percent certainty, although many view this as a 50 percent chance of a 50 basis point cut. With the repo rate at 5 percent, the chance of a 25 basis point cut has risen significantly. The Reserve Bank has also said it could cut the repo rate by 25 basis point.

We ascribe a 45 percent chance of a 25 basis point cut at the monetary policy committee meeting starting tomorrow. Our forecast for flat interest rates therefore remains this year, although there are several factors that appear to support a cut.

A 25 basis point cut in the current environment is more likely to be negative for the rand than to provide any real support to the economy. A 50 basis point cut would see the rand weaken more significantly as foreigners fear temporarily for their yield. Further interest rate cuts could imperil the government’s debt issuance plan.

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