SA’s international credit rating is now below investment grade by all three credit rating agencies, Moody’s, Fitch and Standard and Poor’s.

According to Moody’s “the broader erosion in institutional strength induced by the wide-spread corruption of the Zuma administration is an important factor behind the erosion in SA’s credit profile in recent years. Moreover, the legacy that era has bequeathed of poor governance of state-owned enterprises remains a key drain on fiscal resources.”

The key driver behind the rating downgrade to Ba1 is the continuing deterioration in SA’s fiscal strength and the structurally very weak growth, which Moody’s does not expect current policy settings to address effectively. Furthermore, the outlook for economic growth and government finances are far weaker than Moody’s previously assumed. The negative outlook further reflects the risk that economic growth will prove even weaker and the debt burden will rise even faster and further than currently expected, weakening the government’s debt affordability and potentially, their access to funding.

All of SA’s long-term country risk ceilings were also revised down by one notch.

According to Moody’s, the main factors hurting SA growth are unreliable electricity supply, persistent weak business confidence and investment, and long-standing structural labour market rigidities. As a result, SA is entering a period of much lower global growth in an economically vulnerable position. The government’s own capacity to limit the economic deterioration, given the current COVID-19 shock is constrained. Fiscal space is very limited and looser monetary policy will not address underlying structural problems.

Moody’s argues that progress on structural economic reforms has been very limited. Some initiatives to improve competition and encourage job creation have progressed, but none that constitute a step-change for the economy. Structural issues such as labour market rigidities and uncertainty over property rights generated by the planned land reform remain unaddressed. Moreover, a strategy to stabilise electricity production has been slow to emerge and has yet to prove its effectiveness. Moody’s assumes that while power supply will become more reliable, the restoration of full capacity will take some years to complete. As a result, after the immediate sharp downturn, growth will remain very low in the following years. Stated more simply, we cannot blame COVID-19 for the downgrade, the damage has been inflicted over a number of years and continued to be inflicted in the weeks ahead of COVID-19.

Moody’s highlighted that the unprecedented deterioration of the global economic outlook caused by the rapid spread of the coronavirus outbreak will exacerbate the SA’s economic and fiscal challenges and will complicate the emergence of effective policy responses.

In terms of the fiscal outlook, Moody’s argues that SA’s debt burden will rise over the next five years under any plausible economic and fiscal scenario. More specifically, they expect debt-to-GDP will rise by a further 22 ppts over the period 2019-23. Moody’s expects SA’s primary deficits to persist. The fiscal deficit is expected to widen to around 8.5% of GDP (STANLIB currently estimated 9.5% of GDP), as revenue declines this year. The situation is expected to be aggravated by larger interest payments and the need to support state-owned enterprises. Any progress in terms of fiscal consolidation will rest primarily on containing the large and growing public sector wage bill. Moody’s feels this will “prove challenging to implement.” Moody’s expects expenditure on wages to exceed budget at least in 2020.

Moody’s now estimates that the SA government debt burden will reach 91% of GDP by fiscal 2023, inclusive of the guarantees to state-owned enterprises from 69% at end of fiscal 2019. Even if the government’s plans to restrain wage growth were fully implemented, debt-to-GDP would still continue to rise significantly. Similarly, even under a scenario of more effective improvement in tax compliance and falling interest rates from fiscal 2021, government debt would still rise to around 87% by 2023.

In terms of the risk of a further downgrade, Moody’s flagged that this could occur if any combination of very weak growth, failure to reduce the primary deficit, and rising financing costs was likely to cause the debt burden to rise to even higher levels than currently projected.

Overall, the decision by Moody’s to downgrade SA to below investment grade cannot be a surprise to anybody. Last year it became abundantly clear that SA experienced another further step-change deterioration in economic growth as well as key fiscal parameters and that government was unable or unwilling to address the economic issues with any degree of urgency. Hopefully, the authorities are willing to implement the necessary reforms to avoid a further downgrade.

Accessing the impact of this downgrade on financial market is difficult under current circumstances. It seems fair to argue that the downgrade has been more than priced-into SA’s currency and bond market. It is also important to take into account that on 23 March 2020, FTSE Russell announced that it will postpone the March 2020 month-end rebalances of its various indexes until the end of April 2020. This includes the FTSE World Government Bond Index (WGBI). Consequently, some of the forced selling of SA bonds will, presumably, be postponed to end April 2020. While the rand and bond market might not weaken substantially further as a result of the downgrade, the move to below investment grade by the one credit rating agency that had for many years expressed confidence in SA’s ability to generate an economic revival, will hurt household and business confidence at a time when the country is under enormous pressure.

This is not a time to blame the messenger but rather reflect on the factors that have brought the country to this point and more importantly, on the decisions that need to be taken to get SA back to investment grade.