High Debt Burden, Moderate Growth Potential Hinder Investment Grade for South Africa

Longer-run fiscal risk and moderate economic growth potential remain constraints for an investment-grade rating for South Africa – after Scope Ratings published BB+ ratings – the agency’s first public sovereign rating in Africa.

South Africa’s fiscal deficit is expected to come in at a better-than-anticipated 4.75% of GDP for FY2022/23 (compared with an earlier government target of 6% of GDP) although we expect this to rise to 5.2% in FY2023/24 and see it climbing during future years because of the rise in interest payments amid higher global rates.

Risks to the budgetary outlook include:

1. A renewed recession bringing in lesser tax revenue, and ushering in poorer spending discipline.
2. Higher wage settlements in view of elevated inflation.
3. A further extension or permanent inclusion of the Social Relief of Distress grant – which the government believes could, in lieu of a permanent source of funding, impair sustainability of public finances.
4. Greater-than-anticipated aid for struggling state-owned enterprises; and
5. Higher-than-anticipated borrowing costs.

Substantial risks to the national fiscal framework need to be addressed. Current nominal primary expenditure ceilings, which are prudently announced three years in advance, are a credit strength, as is a robust debt and cash management strategy. But higher spending and failure to observe ascribed expenditure ceilings since FY2018/19 undermine faith in the fiscal framework. The adoption of any debt-ceiling rule could complement an existing fiscal architecture and enhance longer-run fiscal sustainability.

Net Interest Payments Are Seen Rising Above 20% of Revenue by 2024

Scope Ratings considers net interest payments as being a relevant indicator of debt sustainability – reflecting the weight of debt on operational budgetary resources. Net interest payments are expected to average around 18% of government revenue over the next two years before rising to above 20% by 2024. Sustained deficits have translated into a steady rise in the government debt burden, which is elevated by emerging-market standards.

Government debt is seen rising to 73.3% of GDP by 2024, before continuing to increase medium term (Figure 1). Hence, a government expectation in last month’s Medium-Term Budget Policy Statement for a peak of the public-debt ratio at 71.4% by the current fiscal year – two years earlier and nearly four percentage points lesser than previous government estimates – is subject to risk, especially ahead of 2024 general elections.

Figure 1. Debt-to-GDP forecasts, % of GDP

Low Level of Sovereign Foreign-currency Debt Mitigates Effects of Currency Losses for Debt Sustainability

The rand is 7% weaker against dollar since the start of this year, although this has been mainly a dollar-strength phenomenon. The nominal effective exchange rate is largely unchanged. Scope expects the rand to depreciate a further 5% a year against the dollar between 2023 and 2027, close to its average rate of annual devaluation from 2012-21.

However, South Africa’s moderate level of sovereign foreign-currency debt mitigates effects from currency losses for debt sustainability, although an elevated participation of non-residents in the domestic debt market represents a further risk. Non-residents held 26.2% of South African domestic debt as of October 2022.

A Moderate Economic Growth Trajectory Looking Ahead

Following a post Covid-19 crisis rebound (4.9% growth in 2021), Scope Ratings assumes that economic growth eases to 1.8% in 2022 before 1.1% for 2023 (Figure 2). The latter is below growth potential of 1.5% a year. 1.7% growth is seen during 2024. A slower economic growth trajectory will prevail despite annual working-age population changes of 1.5% a year anticipated during 2022-27.

Figure 2. Real GDP growth (%)

Growth remains anchored by economic re-openings from Covid-19, but this impetus fades as the international environment has become more challenging. Weak investment expenditure, long-standing energy and infrastructure bottlenecks (especially in rail), as well as labour-market rigidity weigh on growth potential.

Consumer price inflation came in at 7.6% in October, a slight increase from the 7.5% in September but less than the 7.8% print in July. Inflation is expected by Scope to stay above its 3%-6% target range until Q3 2023 (averaging 7.0% in 2022, 6.3% in 2023 before 4.6% in 2024) and to reach a mid-point of the target range only by mid-2024 – slightly ahead of current central-bank expectations.

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Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Keith Mullin, Senior Editor at Scope Ratings, contributed to writing this commentary.