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SA's outlook revised to negative, but maintains BBB rating - Fitch Ratings

Agency says future downgrade may result from persistently weak GDP growth, failure to narrow current account deficit

Fitch Revises South Africa's Outlook to Negative; Affirms at 'BBB'

13 Jun 2014 12:03 AM (EDT)

Fitch Ratings-London-13 June 2014: Fitch Ratings has revised the Outlook on South Africa to Negative from Stable and affirmed its Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB' and 'BBB+', respectively. The issue ratings on the senior unsecured foreign and local currency bonds have also been affirmed at 'BBB' and 'BBB+', respectively. The Country Ceiling has been affirmed at 'A-' and the Short-term foreign currency IDR at 'F3'.

Fitch has also affirmed the common Country Ceiling of the Common Monetary Area of South Africa, Lesotho (BB-), Namibia (BBB-) and Swaziland (not rated) at 'A-', in line with South Africa's Country Ceiling.

KEY RATING DRIVERS

The revision of the Outlook to Negative reflects the following key rating drivers and their relative weights:

Medium

The outlook for GDP growth has deteriorated. Real GDP contracted by 0.6% (qoq, seasonally adjusted annualised) in 1Q14, reducing the yoy rate to 1.6%. This partly reflects the long strike in the platinum sector, but manufacturing output also fell sharply. Increased strike activity, high wage demands and electricity constraints represent negative supply side shocks. So far, the sharp depreciation of the rand over the past two years has not fed through to clear signs of improvement in competitiveness and growth.

Fitch has revised down its forecasts for GDP growth to 1.7% in 2014 (from 2.8% in its rating review in December 2013) and 3% in 2015 (from 3.5%). Downward growth revisions have become a persistent pattern, pointing to the economy's susceptibility to shocks and possibly weaker potential growth.

Following its election victory in May with 62% of the vote, the African National Congress government faces a challenging task to raise the country's growth rate and improve social conditions, which has been made more difficult by the weaker growth performance and deteriorating trends in governance and corruption. This will require an acceleration of structural reforms, such as those set out in the comprehensive National Development Plan (NDP). In Fitch's view, the track record of some key ministerial appointments and shortcomings in administrative capacity mean this is subject to downside risks.

South Africa's persistent budget deficit is leading to rising public indebtedness. Fitch expects moderate slippage in the consolidated government deficit to 4.2% in 2014/15 from 4% in 2013/14 owing to the growth shock and platinum strike. Reducing the deficit to below 3% of GDP by 2016/17 will be challenging and dependent on a recovery in growth and adherence to tough expenditure ceilings. Fitch estimates general government debt climbed to 48% of GDP at end-2013 from 27% in 2008, above the 'BBB' median of 40%. We project it will peak at around 50% in 2016. National (central) government debt was 46% of GDP at end-2013.

The current account deficit (CAD), which was 5.8% of GDP in 2013, means that South Africa's net external indebtedness is also rising. Fitch estimates it was equivalent to 13% of GDP at end-2013, up from 0% at end-2009, and above the 'BBB' range median of 9%. The deficit also leaves the country exposed to shifts in global liquidity and risk appetite.

South Africa's ratings also reflect the following key rating drivers:

South Africa is supported by several factors that reduce the risk of crises. The floating exchange rate acts as an effective shock absorber for the economy. Foreign currency-denominated debt and dollarisation rates are low. The banking system is strong with a capital adequacy ratio of 15.5% and a Fitch Viability Rating of 'bbb'.

Government debt is largely denominated in local currency (91%) and has a high average maturity of 10 years (including T-bills), which limits exchange rate and financing risk. The central government has cash deposits of 6% of GDP, while deep local capital markets support financing flexibility.

South Africa faces a number of structural weaknesses. GDP per capita is lower and has risen more slowly than in rating peers. Income distribution is one of the most unequal in the world, partly reflecting the legacy of apartheid. Unemployment is high at 25% and the labour market beset with strikes. Frustration with living standards and poor service delivery has continued to fuel a wave of social protests. However, standards of governance and the business climate are better than the 'BBB' median according to World Bank indicators.

Inflation has been higher than in rating peers in the five years to 2013 and consumer price inflation rose to 6.1% in April, breaching the South African Reserve Bank's 3%-6% target. The Monetary Policy Committee commenced a rate rising cycle in January and faces a dilemma in balancing weak growth against above-target inflation, inflation expectations entrenched at the top of the target range, strong wage demands and external vulnerabilities.

RATING SENSITIVITIES

The Negative Outlook reflects the following risk factors that may, individually or collectively, result in a downgrade of the ratings:

- Persistent weak GDP growth and a failure to boost growth potential, for example if there are only modest structural reforms or policy measures that damage the investment climate.
- Material slippage against government fiscal projections.
- Failure to narrow the CAD.

The current rating Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to an upgrade. However, future developments that may, individually or collectively, lead to a stabilisation of the Outlook include:

- An improvement in medium-term growth prospects, for example bolstered by the successful implementation of structural reforms in the NDP.
- A significant reduction in the budget and current account deficits.

KEY ASSUMPTIONS

Fitch assumes that the South African Reserve Bank is committed to maintaining inflation within or close to its 3%-6% inflation target and would act as required to fulfil its mandate.

The agency's fiscal projections are based on the assumption that the government will broadly stick to its budget deficit plans set out in the February 2014 Budget.

Fitch assumes there is no severe and sustained fall in South Africa's terms of trade, for example related to falls in commodity prices.

Fitch's assumption for South Africa's medium-term growth potential is 3.0%-3.5% (from 3.5% previously).

Statement issued by Fitch Ratings, London, June 13 2014

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