The South African Rand "Risks Further Weakness" after Moody's Warning says Investec Bank 

Johannesburg, South Africa, Image © Adobe Stock

- ZAR falls due to ratings concerns, risks further weakness says Investec.

- Moody's to cut ratings outlook, budget plan for Eskom is key for ZAR.

- ZAR to see new record lows if rating goes, but can rise if rating remains.

The Rand is at risk of fresh weakness during the months ahead according to economists at Investec Bank, who say South Africa could see the outlook for its credit rating downgraded if the February budget does not go according to plan. 

Moody's, the last remaining agency to still have an investment grade rating assigned to South Africa, will want to see a credible plan to bring down the budget deficit and put state power utility Eskom onto a sustainable financial footing emerge from the February 20 budget. 

The agency made its voice heard late last week, when it panned President Cyril Ramaphosa's annual State of the Nation Address for lacking sufficient detail on what the government plans to do about Eskom.  

"The move paves the way for a more transparent group with more clearly allocated revenue and cost between business segments," Moody's says, in a statement following the SONA. "However, in and of itself it does little to address Eskom's financial challenges." 

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.

Ramaphosa had said in the SONA that Eskom could be broken up and difficult choices will have to be made today in order to avoid more painful ones later on, which was widely seen as a reference to electricity price hikes and redundancies for workers. 

The government is on the hook for ZAR 350 bn (£21 bn) of Eskom's mammoth debt pile, which is equivalent to around 8.5% of national GDP. Although the company has only drawn on just more than ZAR 250 bn of guarantees. 

"SA is likely to see its outlook on its Moody’s dual long-term debt (local and foreign currency) credit rating drop from stable to negative this year," warns Annabel Bishop, Investec's chief economist. "The rand weakened to R13.77/USD, R15.57/EUR and R17.78/GBP today, and risks further weakness."

Above: Eskom debt levels and outline of government guarantees. Source: Investec Bank.

Some observers have described Eskom's predicament as a death spiral and one that could ultimately take the South African taxpayer down with it, although it's not the only problem the government has to contend with.

Last week's SONA was delivered in an election year and at a time when South Africa is under pressure from Moody's to reduce its budget deficit and stem the increase in net-debt or face losing its top credit rating.

High levels of poverty and unemployment mean the government is under pressure to spend more on investment and welfare rather than to cut back, which makes calibrating 2019's budget a task that could be fraught with risk.

Loss of the investment grade rating would force many international creditors to sell their government bonds and effectively leave the country, which analysts say would lead to higher interest rates and a much weaker Rand at the least. 

"The public sector borrowing requirement has risen from close to 0% of GDP in the 2000s to 3.5% of GDP, the fastest growth item in the budget. Government current expenditure (which excludes infrastructure but includes civil servants’ salaries) has risen to 30% of GDP, from closer to 20% in the 2000s," says Bishop.

Above: South African government debt. Source: Investec Bank.

South Africa has a budget deficit that is approaching 4% of GDP and national debt that is now in excess of 50% of GDP, both of which are too high for the liking of ratings agencies.

Poor governance has seen borrowing and spending rise sharply in recent years, while slow economic growth and institutional decay mean South Africa's tax take has not grown fast enough to offset the former. 

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 said at the time it had been encouraged by a change in political leadership that came after Ramapahosa took over the presidency from Jacob Zuma. However, one of the main reasons it took heart from the transition is it hoped corruption would be routed from key institutions and struggling state-owned-enterprises would be fixed. 

Moody's will review its rating on March 29, more than a month after the budget is delivered, and Bishop is looking for the outlook on South African debt to be cut to negative but the actual rating to remain at "investment grade". 

"With the general election scheduled for 8^th May, SA also risks a build-up of sharp populist rhetoric, and resultant policy uncertainty and rand weakness. The down case is one where SA loses its investment grade rating," Bishop warns. 

Above: Investec Bank exchange rate forecasts for worst-case scenario rating outcome. 

Bishop says the Pound-to-Rand rate would rise to 25.92 by year-end if South Africa loses the top credit rating and the USD/ZAR rate would hit 18.50, both of which would represent fresh record lows for the Rand. There is a 37% probability of that happening, Bishop estimates.

However, her most likely scenario is that South Africa clings onto its rating following another turbulent year and that the Pound-to-Rand rate rises to only 18.27 this year and the USD/ZAR rate falls to 13.05. Bishop estimates there is around a 42% probability of that happening. 

The Pound-to-Rand rate was quoted .18% higher at 17.76 Tuesday and has risen 2.54% in the last week, although it's still down -2.7% for the 2019 year-to-date. The USD/ZAR rate has risen 3.07% in the last week to trade at 13.78 Tuesday, although it's down -3.9% this year.

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