SA’s debt sustainability: Downgrade priced in

By Rukayat Yusuf, Bank of America Merrill Lynch’.

Key sources of debt vulnerability in South Africa continue to stem from weak growth and revenue shortfalls. We are closely watching Eskom liabilities and rate shocks triggered by global risk-off and upcoming Moody’s rating decisions, although we think a downgrade to sub-Investment Grade (IG) is now priced in.

Growth, deficit and rates shocks are South Africa’s main vulnerabilities

Including announced Eskom support,  we now project main budget deficits of 5.8% of GDP this year and 6.1% in 2020, with public debt breaching 60% of GDP by next year. Such fiscal deficits would be about 1.5% of GDP above February budget projections. Authorities increased domestic issuance by ZAR1.2bn to ZAR4.5bn per week following the passage of the Eskom Appropriation Bill in July.

As the FX-denominated sovereign debt is still small at 5.9% of GDP (~10%), ZAR devaluation in itself would have the least impact on debt dynamics. We estimate a sustained 30% FX shock would add 2% of GDP per annum to the debt profile in the medium term. The main channels of debt deterioration are, however, from growth and deficit shocks. We estimate that a 2% deficit or growth shock would add 3-5% of GDP to debt within a year in our stress scenarios.

We forecast growth of 0.5% this year and 1.1% in 2020, although our estimates are facing downside risks from trade war escalation and slowing China and Eurozone growth. We previously estimated that a 1% shock to China and G7 growth could shave 0.6% and 1.3% respectively off South African output within four quarters. In addition, we estimate that a sustained 100bps rate shock could add about 5% of GDP to the debt profile over four years.

Eskom: more support likely in October mid-term budget

Eskom will receive an additional ZAR59bn in support from the National Treasury in FY19/20 and FY20/21, with a ZAR26bn cash injection in the first year, and ZAR33bn in the second. This is in addition to the ZAR23bn pa already budgeted for. This adds about 0.5% of GDP to our fiscal deficit projections in each year.

The government has appointed a Chief Restructuring Officer (CRO), Freeman Nomvalo, whose initial focus is on assessing the various options to address Eskom’s capital structure via a close dialogue with rating agencies. A whitepaper should be released, providing a roadmap for the Eskom turnaround, now expected by the end of September. We think a partial debt transfer to the State is still a likely scenario, although outright debt transfers and debt equity swaps are also being considered.

We previously estimated that a domestic (and external) government guaranteed debt transfer from Eskom is likely to add 0.2% (0.4%) to the budget deficit this year and 3% (6%) to the public debt-to-GDP profile.

Moody’s move to sub-IG now likely in 2020

In the absence of more meaningful progress on growth reforms and measures to contain SOE liabilities, we would expect Moody’s to move South Africa’s Baa3-rated local debt to negative outlook after the October Budget and downgrade to sub-investment grade after the February main Budget. The next scheduled Moody’s review is on 1 November.



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