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Credit ratings downgrade for SA and other emerging economies in perspective

17 Nov 08          

Kevin Lings and Melissa Rankin of Stanlib Economics and Group Retail Investing write that Fitch Rating Agency have reviewed the credit rating for 17 emerging market economies. As would be expected, there have been a number of down- grades and outlook revisions, including to South Africa.

In South Africa's case our credit rating remains unchanged at BBB+, but the outlook has been revised down from 'stable' to 'negative'. This implies that there is a more than 50% chance that South Africa's credit rating will be revised lower within a period of 18 months. This revision to the outlook is not surprising given South Africa's large current account deficit.

This review by Fitch is obviously as a result of the dramatic downturn in activity in the world's largest economies, which Fitch now believes will be as long and as deep as the recessions of the early 1980s and 1990s. This combined with worsened terms of trade for commodity exporters as well as reduced capital and financial market flows, implies that many Emerging Economies will have to adjust to lower real incomes and investment as well as increase domestic savings.

Moreover, the suddenness of the deterioration in the global economic and financial environment exacerbates the risks of policy errors as well as the severity of the economic adjustment.

The review focused on the following three risk factors:

  • Vulnerability to reduced availability of international financial and capital flows and the capacity of the economy and the macroeconomic policy framework to respond to this negative shock.
  • Impact of lower oil and commodity prices.
  • Exposure to recession in the world's largest economies.

    and made the following adjustments:

    Downgrades
    Bulgaria: BBB Negative Outlook to BBB- Stable Outlook
    Hungary: BBB+ Negative Outlook to BBB Stable Outlook
    Kazakhstan: BBB Negative Outlook to BBB- Negative Outlook
    Romania: BBB Negative Outlook to BB+ Negative Outlook

    Outlook Revisions
    Chile A: Revised from Positive to Stable
    Korea A+: Revised from Stable to Negative
    Malaysia A-: Revised from Positive to Stable
    Mexico BBB+: Revised from Stable to Negative
    Russia BBB+: Revised from Stable to Negative
    South Africa BBB+: Revised from Stable to Negative

    Affirmations
    Brazil: BBB- Stable Outlook
    China: A+ Stable Outlook
    India: BBB- Stable Outlook
    Peru: BBB- Stable Outlook
    Poland: A- Stable Outlook
    Taiwan: A+ Stable Outlook
    Thailand: BBB+ Stable Outlook

    In revising the outlook for South Africa from 'stable' to negative', Fitch made the following key points about South Africa:

  • Unlike other Emerging Markets, South Africa has not needed to provide direct or indirect local or foreign currency support to its banking system, which remains one of the strongest amongst emerging markets.
  • Moreover, its macroeconomic policy framework, a key rating strength, has remained robust in the face of volatility in global financial markets and the South African Reserve Bank has not intervened to support or smooth volatility in the foreign exchange market despite the sharp fall in the value of the rand.
  • The rationale for the revision of the sovereign rating outlook from Stable to Negative is, however, given a current account deficit in excess of 7% of GDP that is largely funded by portfolio equity and debt flows, the risk of a hard landing and even recession has increased significantly, given the expected reduction in capital and financial flows to emerging market economies.
  • The policy challenges are compounded by still relatively high inflation and in the event of a recession, the political commitment to the current macroeconomic policy framework could be tested.

    Retail Sales Remain Under Pressure
    Stats SA have released the retail sales data for September 2008. According to this latest survey, retail sales fell by a very substantial 5.0%y/y in real terms in September. This compares with a revised decline of 5.6%y/y in August. In 2007 as a whole, sales grew by an average of 5.1%, down from 9.6% in 2006. At this stage of the year it is clear that retail sales will decline for 2008 as a whole, probably by around 3.5%y/y.

    Unsurprisingly, consumer confidence has weakened dramatically in recent months, and is currently well below the 25 year average. Under current economic circumstances it is not really possible for the consumer to take on additional debt to compensate for the lack of discretionary spending power. This is because the consumer is already highly leveraged facing elevated interest rates.

    In addition the NCA, coupled with the global credit squeeze is resulting in the banks being extra conservative in the granting of credit, especially consumer credit for consumption purposes. This is reflected in massive slowdown in the use of credit card debt, which has fallen from an annual growth rate of 37.5%y/y in September 2007 to the current annual growth rate of only 5.0%y/y.

    Instead, the consumer will clearly have to curtail the rate of growth in debt. The overriding conclusion is that consumer spending on items such as cars; furniture, household appliances, clothing, home ware, hardware, eating places, entertainment, music, books, investment products, sporting goods, jewellery etc will be under enormous pressure for the next 12 to 18 months.

    There is also an increased risk of distress borrowing as consumer cling to recent lifestyles and/or find they have over-indulged over the previous four years. The risk of bad debts has, and will continue to rise.

    SA Manufacturing Under Pressure in Q3 2008
    In September 2008, SA manufacturing production declined by 0.6%m/m (seasonally adjusted), which was below expectations for manufacturing to remain unchanged. On an annual basis, the growth in production actually rebounded to 4.9%y/y from a mere 0.5%y/y in August, but this was purely due to base effects, helped by a massive 45%y/y increase in motor vehicle production in September 2008, due to a strike in the industry during September last year.

    Unfortunately the manufacturing data has been extremely volatile on a monthly basis during 2008. This is partly due to the disruptions caused by the electricity outages. There is little doubt that the manufacturing sector will make a negative contribution to the SA GDP growth in Q3 2008, which will be well down on the massive +2.3 percentage points it contributed in Q2 2008.

    Manufacturing activity rose sharply in Q2 2008, following a weak performance in Q1 2008 that was mostly as a result of the electricity outages in that quarter. However, the sector is now under significant pressure, which is set to intensify in the months ahead. The current slowdown in manufacturing activity was expected, given the high base established in Q2 2008, as well as further signs that the domestic economy has continued to weaken in Q3 2008. This is confirmed by the RMB/BER business confidence reading for Q3 2008, as well as the weak Investec PMI manufacturing reading over the past three months.

    The increases in interest rates; a drop-off in residential housing activity, a recession in many aspects of consumer spending (especially motor vehicle sales), and sluggish world demand are all likely to work-against manufacturing activity over the next 6 to 12 months. The most recent weakness of the exchange rate may help to offset some of the domestic economic conditions especially in terms of making manufactured imports more expensive. In addition, the public sector's infrastructural programme remains sound, but these factors are unlikely to be sufficient to offset a general slump in manufacturing activity.

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