Political events over the last two weeks have earned South Africa the distinction of having had four finance ministers over a fifteen month period. Last month’s decision by President Jacob Zuma to reshuffle the cabinet and replace the finance minister, Mr. Pravin Gordhan, and his deputy marked the culmination of a long power-struggle between the president and the finance ministry over control of state resources. The fall-out from that decision was immediate with significant pressure on South African assets. More importantly, S&P downgraded South Africa’s sovereign debt one notch to sub-investment grade and kept a negative outlook citing increasing fiscal risks and policy paralysis due to political splits within the government. Both Moody’s and Fitch issued statements outlining similar concerns with Moody’s going a step further, putting the sovereign on review for a downgrade.
There are a number of reasons for this latest move by the presidency but the most immediate is Mr. Zuma’s quest to ensure an African National Congress (ANC) win spearheaded by his preferred candidate in the 2019 general elections. In recent years, the ANC party has lost some support amongst its constituents. This was apparent in last year’s local elections where the ANC lost its majority in several key states. As a result, there has been a shift in the party’s focus with inclusive social transformation taking a more prominent role amongst Mr. Zuma’s supporters at the cost of fiscal discipline. What form this social transformation takes is not clearly articulated but what is clear is that in this new world, there is little room for a fiscally conservative finance minister. Therefore the decision to replace Mr. Gordhan, who had won back fiscal credibility for the nation over his short tenure, with a relatively unknown candidate raises uncertainty around the future economic and financial policies of the government.
Prior to this, there had been some improvements in the macro data in recent months as the country’s terms of trade benefitted from a weaker currency and rising commodity prices. Inflation also appeared to be moderating due to lower food prices and a stable currency. As a result, there was a building expectation that the central bank would commence a rate cutting cycle given relatively subdued growth. This coupled with shifting momentum on the macro-economic front had seen an increase in foreign investments into the local bond markets.
With last week’s events, political uncertainty is likely to overshadow an improving macro picture and could see further underperformance of South Africa’s assets as the ratings cycle turns more negative. This in turn will push back the rate cutting cycle and could prompt rate hikes should the currency move become disorderly; a high risk should we see a reversal of flows materialise. Moody’s and Fitch are likely to follow S&P in downgrading South Africa in the coming months, resulting in a loss of South Africa’s dollar debt’s eligibility in investment grade only indices. While experience from other emerging markets has proven that to be a good buying opportunity, the removal of the ratings downgrade overhang will only serve to remove any incentive from the administration to adhere to fiscal targets. Signs of a strong and credible opposition to the current president or adherence to fiscal consolidation and economic reform could turn the tide for sentiment. Although it’s early days for the new finance minister, changes in the national treasury stance on key topics (e.g. nuclear energy) that would have an adverse impact on the budget suggest this is unlikely to be the case and suggests there are further headwinds yet to materialise for South African assets.