Rand Rebounds after Ramaphosa Grabs Eskom by the Horns in SONA 2019

© Government of South Africa

- ZAR rebounds following Ramaphosa's 2019 SONA address.

- Market cheers government's plan to fix Eskom, save credit rating.

- But UBS says to sell ZAR as the good news is already in the price.

The Rand pared losses against rivals in a risk-off market Thursday after President Cyril Ramaphosa set out plans for righting the capsized ship that is national power utility Eskom, and reaffirmed his commitment to saving the nation's top credit rating.

Speaking during the annual State of the Nation Address (SONA), Rampahosa said painful decisions must be taken now in order to avoid even greater trauma at a later date, in an apparent referrence to Eskom's request for a double-digit electricity price increase in each year for the next three years.

Revenue must rise and operating costs fall if the government is to avoid having to inject substantial sums of cash into Eskom over coming years, which would be almost certain to prompt a credit rating downgrade from Moody's if allowed to happen. This means price increases and job cuts.

Ramaphosa also endorsed a nine point turnaround plan put forward by Eskom itself that will see the company carved up into three separate operating units focused on power generation, transmission and distribution.

The new companies and their parent will still be owned by the taxpayer, although the new structure will make any future privatisation easier. Ramaphosa says the break up is necessary because Eskom needs a new business model.

In addition, measures will be put in place to improve payment by local municipalities and South African households, as non-payment by customers has been a significant driver of Eskom's cash-flow problems in the past. 

"The president did not shy away from the Eskom issue, offering stern words of warning if the failing operational and financial health of the utility was left unchecked. The government is acutely aware that Eskom's instability poses a risk to the country and decisive actions cannot be delayed," says Nema Ramkhelawan-Bhana, an analyst with RMB.

The admission from Ramaphosa ends months of speculation over Eskom's future although it is not yet clear whether it will be enough to address market fears over the financial risk it presents to the government, as neither a break-up nor well meaning plans on collections will be enough to immediately improve the company's fortune.

Nonetheless, commitment to raise prices, radically restructure the company and retain South Africa's investment grade rating was enough to prompt a bid for the Rand, which condensed a 1% loss against the Dollar into just a 0.5% decline following the speech. 

The USD/ZAR rate was quoted 0.38% higher at 13.58 following the address Thursday but has fallen -5.4% so far in 2019. The Pound-to-Rand rate was 0.59% higher at 17.59  but has fallen -3.26% this year. 

Thursday's SONA was delivered in an election year and at a time when South Africa is under pressure from ratings agencies to reduce its budget deficit and stem the increase in net-debt. If Ramaphosa cannot satisfy Moody's in particular over the coming months, the nation could lose its top credit rating. 

Eskom, the national electricity monopoly, has revenue and cash flows that are not enough to cover its costs, while years of under-investment and poor management have left its capacity to generate and supply power to South African households greatly reduced.

Some observers have described the predicament as a death spiral and one that could ultimately take the South African taxpayer down with it because the national treasury is on the hook for as much as ZAR 350 bn of Eskom's debt.

"Without a clear, realistic plan on how to reduce the budget deficit and turn around ailing SOEs, market participants will likely focus again on the risks of a downgrade of South Africa’s last local investment grade rating by Moody’s, which would trigger sizable outflows out of the local bond market and pressure on the rand," says Tilmann Kolb, from the chief investment office of UBS.

Kolb told UBS' clients Thursday they should sell the Rand because all of the good news to have emerged from South Africa during recent months is already in the price, while there is scope for substantial losses from current levels if markets begin to fear for ratings outlook again.

Moody's gave South Africa a reprieve in March 2018 when it left the nation's credit ratings intact at Baa3, which is just about inside the "investment grade" threshold and only one notch above "junk status". It upgraded the outlook from negative to stable at the same time. 

The agency, which is the only one to still rate South Africa as investment grade, said at the time it had been encouraged by a change in political leadership that came after  Rampahosa took over the presidency from Jacob Zuma. 

However, one of the main reasons it took heart from the transition is the agency hoped corruption would be routed out of key institutions and that  state-owned-enterprises such as Eskom would be fixed. 

"High and rising concerns regarding endemic high-level corruption, 'state capture' and pressures on the mandate and independence of key policy-making institutions such as the Reserve Bank have materially damaged economic confidence and effective policy-making, exacerbating the erosion in the government's balance sheet," Moody's said at the time. "Examples of the erosion of the government balance sheet are diverse, but include the increasingly entrenched financial challenges facing key SOEs."

One of Ramaphosa's first acts as President was to replace the entire board of Eskom but new management alone is not enough to immediately turn around the ship. Price increases and job cuts may be the only way the government is able to help Eskom financially without drawing the ire of Moody's, but they won't help Ramaphosa's popularity in an election year, given the economy has only recently exited recession and the growth outlook is highly uncertain.

"Debt trajectories for a number of sovereigns remain vulnerable to lower-than-expected growth, exchange rate depreciations and contingent liability risk from weak state-owned enterprises. Debt affordability will continue to weaken in a number of countries," Moody's said in January 2019, referring to the Sub-Saharan Africa region.

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