South Africa: Heightened political risk affects the country's economic outlook
April 19, 2017
South Africa’s economic outlook has taken a turn for the worse after Fitch became, on 7 April, the second credit ratings agency to downgrade the country’s sovereign rating from investment grade to junk. Fitch’s decision followed a similar move by S&P Global on 3 April. Both downgrades are the direct result of a cabinet reshuffle carried out by President Jacob Zuma on 31 March, in which he sacked his respected Finance Minister Pravin Gordhan and four other ministers, and replaced them with loyalists. Zuma’s move is seen heralding a potential retreat from fiscal prudence, a rise in wasteful spending—including a controversial plan to expand the country’s nuclear power program—and increased opportunities for patronage.
The initial shockwaves of the reshuffle and the consequent credit rating downgrades were felt in the rand, which fell 2.5% from the previous month at the end of March, trading at 13.41 ZAR per USD, and continued to weaken in April, touching a low of 13.92 ZAR per USD on 10 April. Pravin Gordhan was replaced by Malusi Gigaba, who has insisted that the fiscal targets stipulated in the 2017 budget will be met. However, unlike Gordhan, Gigaba lacks the authority to defy presidential instructions.
Fitch’s downgrade is potentially more damaging than S&P’s as, apart from cutting South Africa’s foreign-currency credit rating to junk, the ratings agency also lowered the country’s domestic-currency credit rating by the same margin. S&P had left it unchanged, although with a negative outlook. South Africa’s local-currency rating is arguably a more important measure, as foreign-held rand-denominated debt exceeds the country’s foreign-currency debt. Should two ratings agencies denominate South Africa’s local-currency debt non-investment grade, this would induce investment funds to dispose of their holdings, prompting massive capital flights and putting pressure on the balance of payments.
Risks to South Africa’s economic outlook, investment and much-needed capital flows are tilted to the downside, as they depend to a large extent on the direction of politics. Signaling a new twist in the long-run land reform debate, President Zuma called in both February and March for expropriation without compensation. Recognizing that such a policy shift will require a change in the country’s constitution, Zuma called on the ruling African National Congress (ANC) party to seek support from other parties, as it is 18 seats short of the threshold required to make constitutional amendments. The ANC is unlikely to heed the President’s call since it remains committed to compensation in cases of expropriation. The dispute nevertheless highlights the rising divisions within the party and stresses the risks of Zuma pushing an increasingly populist agenda, which will not do much to encourage private sector investment in the country.
Author: Ricardo Aceves, Senior Economist