South Africa Outlook Downgraded over Acute Electricity Shortage

South Africa’s outlook has been downgraded to stable as infrastructure shortfalls weigh on growth, S&P ratings said in a statement. In its rating note, S&P noted that economic growth in South Africa is facing increasing pressure from infrastructure constraints, particularly severe electricity shortages.

It said reforms to address infrastructure shortfalls and to improve governance and performance at state-owned enterprises (SOEs) are slow, weighing on growth, while contingent liabilities from SOEs pose continued downside risks to South Africa’s fiscal and debt position.

“We, therefore, revised our outlook on South Africa to stable from positive, reflecting these risks. We affirmed our ‘BB-/B’ foreign currency sovereign credit ratings on the country”, S&P said in its rating note.

Outlook

According to S&P Ratings, the stable outlook on both the foreign and local currency ratings balances South Africa’s credit strengths–particularly a credible central bank, a flexible exchange rate, an actively traded currency, and deep capital markets–against infrastructure-related pressures on growth, and downside risks to the fiscal and debt position.

Downside scenario

“We could lower the ratings if the ongoing implementation of economic and governance reforms does not progress as planned, resulting in further deterioration in economic growth, or higher-than-expected fiscal financing needs.

“This could, for example, result from a deepening of the electricity crisis or if critical infrastructure constraints worsen”, it said.

Upside scenario

“We could raise the ratings if there is an improving track record of effective reforms, resulting in structural improvements in economic growth alongside a reduction in public debt and contingent liabilities”.

Rationale

Despite the government’s attempts at reforming the power sector, acute electricity shortages pose downside risks to both short- and medium-term growth prospects. The economy contracted by 1.3% on a quarterly basis in the fourth quarter of 2022 as electricity cuts rose sharply over the period.

The downturn was broad-based, with the agricultural and mining sectors seeing the largest declines. Full-year 2022 real GDP growth now stands at 2.0% while real GDP growth forecast for 2023 has also been lowered to 1.0% from 1.5% previously and expected growth to average 1.7% in 2024-2026.

Downside risks to this forecast remain prominent since South Africa has been unable to fully capitalize on the global upswing in commodity prices while continued electricity shortages signal a potentially difficult winter ahead. Structurally high income inequality and unemployment remain, particularly among young people, S&P stated.

The rating note stated that the government has introduced measures to encourage private sector and renewable electricity generation, but it will take time for additional power supply to materially improve electricity availability for the wider economy.

The announcement of a national state of disaster on Feb. 9, 2023, and the appointment of a minister, Kgosientsho Ramokgopa, in the newly created Electricity Ministry on March 6, 2023, was intended to fast-track measures to tackle the electricity crisis.

However, concerns have been raised around possible mismanagement of allocations under fast-tracked procurement processes, and the multiplicity of ministries that Eskom now reports to, including the new Electricity Ministry, the Department of Public Enterprises, and the Ministry of Energy.

The track record of procuring and constructing sufficient new electricity generation to offset breakdowns and maintenance of an ageing coal-fired power fleet has been poor.

Contingent liabilities tied to power utility Eskom and other SOEs are likely to remain a risk to the economy and the government’s fiscal position until there is an adequate track record of improvements in operational and financial performance among these entities.

The government announced a sizable debt relief package for Eskom, amounting to South African rand (ZAR)254 billion ($14.7 billion), which is in line with our previous expectations.

The relief is earmarked for Eskom to repay its upcoming debt obligations and meet financing needs over the next three years and is intended to thereby provide sufficient financial room for Eskom to address maintenance and capital expenditure needs.

The relief is in the form of loans from the National Treasury to Eskom amounting to ZAR78 billion in fiscal 2023 (year ending March 31, 2024), ZAR66 billion in fiscal 2024, and ZAR40 billion in fiscal 2025, alongside the government taking up to ZAR70 billion of Eskom’s debt directly onto its balance sheet in fiscal 2025.

Eskom will be prohibited from taking on any other new debt over the period, and the loans will be converted to equity after Eskom meets quarterly conditions set out by the National Treasury.

“Should Eskom not meet quarterly conditions, it will be given three months to remedy this, and thereafter Eskom will become liable to pay interest on these loans from the Treasury.

“We understand that the loans under the relief package are subordinated to Eskom’s other loan …Including the new debt that the government will need to raise for Eskom, we forecast general government debt will rise to 78.7% of GDP in fiscal 2026 from 71.5% of GDP in fiscal 2022”, S&P said.

it said revenue is at risk from the economic impact of electricity shortages. Government expenditure also faces slippages related to potentially higher wage settlements or transfers to SOEs and the possibility that the Social Relief of Distress grant could become permanent over the medium term.

On Feb. 24, 2023, the Financial Action Task Force (FATF) included South Africa on its grey list of countries with structural deficiencies in monitoring, preventing, and combating money laundering, terrorism financing, and illicit financial flows.

These deficiencies relate to failures in pursuing cases tied to the misuse of public funds during the “State Capture” era under the previous administration.

“We believe the greylisting could weigh on government borrowing costs and raise financial transaction and compliance costs for the economy and trade flows”.

However, S&P said it’s unlikely to significantly affect South Africa’s creditworthiness since the government retains access to deep domestic capital markets.

“We estimate South Africa’s current account deficit (CAD) at 0.7% of GDP in 2022, slightly below the near balanced position we had previously anticipated–but a relatively weak outturn given the level of commodity prices”.

This is largely on the back of a sharp rise in imports, while commodity export volumes were restricted by rail network breakdowns, insufficient rail capacity, strike action, and electricity shortages.

S&P said it expects the CAD will average 1.6% of GDP in 2023-2026 and widen to 1.9% by 2026 as commodity prices moderate in line with easing global growth.

Nevertheless, South Africa’s relatively small external debtor position, with narrow net external debt (NNED) averaging 26.0% of current account receipts (CAR) over 2024-2026, provides a buffer against rising global headwinds, but weakening external balances will see buffers moderate through 2026.

Inflation-related pressures have led the South African Reserve Bank (SARB) to raise rates by 375 basis points since late 2021. The repo rate currently stands at 7.25%. Inflation has begun moderating slightly and should enable the SARB to moderate the pace of rate hikes.

Inflation peaked at 7.6% in October 2022, and moderated to 6.9% in January 2023. We expect inflation to fall back within the SARB’s 3%-6% target range this year, with headline inflation averaging 5.8% over 2023.

“Our ratings on South Africa balance the risks highlighted above against a reasonably small, albeit increasing, net external debtor position, its flexible currency, and deep domestic capital markets that should cushion against rising external financing risks”.

It said the ratings also reflect the reasonably strong checks and balances embedded within South Africa’s institutional framework, which includes a constitutionally independent judiciary, an independent central bank, and largely free media.

Following past years of weakening state institutions and mismanagement of public funds, the current administration under President Ramaphosa and the courts have tried, with mixed results, to strengthen various institutions–such as the tax revenue authority, government-related entities, and the national prosecuting authority.