SA sovereign rating overview - PSG

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SA sovereign rating overview 5 December 2016

Contents 1. 2. 3. 4. 5. 6. 7.

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Review results Rating factors Our base case Relative ratings – emerging market (EM) peers Global growth challenges Outlook for markets Bottom line

1 | Review results - S&P Global Ratings 2 December 2016

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Affirmed foreign currency ratings at BBBLowered local currency rating to 'BBB' from 'BBB+' • •

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The concern has always been our sovereign rating – which mainly refers to our foreign currency rating or ability to repay foreign debt S&P rationale for lowering the long-term local currency ratings: - SA depends on resident and non-resident purchases of rand-denominated local currency debt to finance its fiscal and external deficits - This is beyond S&P’s previous expectations - General government debt set to increase: 4.9% of GDP in 2016-2018 (gross debt of 54% of GDP in 2019) - Proportion of rand in global foreign exchange turnover - declined to just below 1% over past three years S&P still believes political events have distracted from growth-enhancing reforms Low GDP growth continues to affect SA’s economic and fiscal performance and overall debt stock Foreign currency ratings reflect S&P views of the country's large and active local currency fixed-income market, as well as the authorities' commitment to gradual fiscal consolidation S&P also noted SA's institutions, such as the judiciary, remain strong while the South Africa Reserve Bank (SARB) maintains independent monetary policy The negative outlook reflects the potentially adverse consequences of persistently low GDP growth on the public balance sheet, in the next one to two years S&P decision of 2 December falls in our base case SOURCE: S&P Global Ratings

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South Africa’s ratings history

SOURCES: PSG Wealth research team, S&P Global Rating

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Wealth levels are declining due to low GDP Growth and rand weakness in recent years


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2 | Rating factors

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Republic of South Africa ratings score snapshot

Key rating factors Institutional assessment Economic assessment External assessment Fiscal assessment: flexibility and performance Fiscal assessment: debt burden Monetary assessment SOURCE: S&P Global Ratings

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Jun-16 Neutral Weakness Neutral Weakness Neutral Strength

Dec-16 Neutral Weakness Neutral Weakness Neutral Strength

Institutional assessment S&P affirms SA has strong democratic institutions • •

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South Africa has a strong democracy with independent media and reporting S&P believes SA will maintain institutional strength, particularly regarding the judiciary. This provides checks and balances and accountability where the executive and legislature has appeared less willing to do so The government has set up a commission into minimum wages, which has provided a starting point for negotiations with business and labour unions However, political tensions are still high Tensions and contestations to increase in run up to ANC’s December 2017 elective conference This could weigh on investor confidence and exchange rates, and potentially affect government policy direction Domestic capital markets are well developed

Economic assessment Low GDP growth may impact on tax revenue collections

SOURCE: Treasury, Reserve Bank, IMF, S&P Global Ratings, PSG Wealth research team

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What is constraining GDP growth? •

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Domestic factors constraining GDP growth - Electricity supply constraints - Labour issues in the real sectors - Weather patterns - Weak business confidence (low investment) - Policy implementation challenges S&P has revised down our real GDP growth assumptions for 2016 to 0.5% and 1.4% for 2017 - last June they forecast 0.6% for 2016 and 1.5% for 2017 Their revised projections are contingent on global growth and, in particular, SA’s terms of trade “The economy remains directly and indirectly linked to demand for commodities, especially from China. We estimate that real GDP per capita will stand at US$5,300 in 2017.” SA government faces risks from non-financial public enterprises with weak balance sheets, which may require more government support than S&P currently assumes

External assessment SA’s gross external financing needs are large

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Averaging over 100% of current account receipts (CARs) plus useable reserves However, they are declining because the current account deficit is narrowing Trade deficit is declining on the lower price of oil (about one-fifth of South Africa's imports) External factors constraining GDP growth: - Weak external demand - Low commodity prices - Subdued global growth

Fiscal assessment: flexibility and performance Real exports growth likely to be slow • • • • •

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Real exports growth likely to be slow over 2016-2019 on persistent supply-side constraints to production Import growth will be compressed, amid currency weakness and the subdued domestic economy S&P estimates current account deficits will average below 4% of GDP (or 11% of CARs) over 2016-2019 SA funds part of current account deficits with portfolio and other investment flows, which can be volatile Such volatilities could result from global changes in risk appetite, foreign investors reappraising prospective returns in the event of growth, policy slippage in South Africa or rising interest rates in developed markets

Fiscal assessment: debt burden Fiscal forecasts suggest stabilisation may be near


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Rising exposures to state owned entities with weak balance sheets Rising debt servicing costs as domestic interest rates increase

Monetary assessment SA continues to pursue floating exchange rate regime • • • • • • • •

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SARB does not have exchange rate targets and does not defend any particular exchange rate level S&P sees SARB as being operationally independent and its policies as credible SARB uses inflation-targeting framework for its monetary policy The bank also uses open market operations to manage liquidity, including sterilising its purchases of foreign exchange inflows The repurchase (repo) rate is the bank's most important monetary policy instrument Despite lower oil prices, a weaker exchange rate and higher electricity prices have increased inflationary pressures SARB expects inflation to remain higher than its 3%-6% target range in 2016 and early 2017 SARB has tightened by 75 basis points of cumulative hikes in 2016

3 | Our base case

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Our original base, bear and bull case

SOURCE: PSG Wealth research team

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Base case S&P Global Ratings keeps our sovereign rating a notch above junk status • •

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S&P Global Rating warned earlier that political instability would be a risk to South Africa’s sovereign credit rating However, some political events were positive for our economic and credit-ratings outlook - Withdrawal of charges against finance minister Pravin Gordhan - Good medium-term budget - Release of the public protector’s report on state capture Above boosted faith in our democratic institutions and highlighted our government’s commitment to fiscal consolidation. This could mean greater confidence, greater investment and a more vital economic outlook. In their review released on Friday, 2 December, S&P said: “Political tensions are still high…these will increase in the run up to the ANC’s December 2017 elective conference. We think that ongoing continued tensions and the potential for event risk could weigh on investor confidence and exchange rates, and potentially affect government policy direction…. The negative outlook reflects the potential adverse consequences of persistently low GDP growth on the public balance sheet, in the next one to two years.”

Review meets our expectations • • • • • •

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We expected our sovereign credit rating to remain at BBB- with a negative outlook As such we don’t expect any extreme market volatility to occur Bond yields should stay relatively stable The rand could strengthen marginally as further uncertainties wane Near term: the currency could strengthening to below three standard deviations from the purchasing power parity (PPP) Long term: we envisage equity returns to continue to outperform inflation and cash

4 | How does South Africa compare to its EM peers?

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Credit ratings of EM peers

Fitch ratings

South Africa Brazil Russia Turkey Romania Hungary India

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S&P Global Ratings Moody's ratings

BBB- (Dec 15 downgrade) Negative outlook (Nov 16)

BBB- (Jun 14 downgrade) Negative oulook (Dec 15)

Baa2 (Nov 14 downgrade) Negative outlook (May 16) Rating unchanged (Nov 16)

BB (May 16 downgrade)

BB (Feb 16 downgrade)

Ba2 (Feb 16 downgrade)

BBB- (Jan 15 downgrade)

BB+ (Jan 15 downgrade)

BBB- (Aug 2016)

BB (Nov 16)

Ba1 (Feb 15 downgrade) Ba1 (Sept 16)

BBB- (Apr 15

BBB- (Apr 15)

Baa3 (Apr 15)

BB+ (Apr 15)

BB+ (Apr 15)

Ba1 (Apr 15)

BBB- (Apr 15)

BBB- (Apr 15)

Baa3 (Apr 15)

EM countries ratings at risk since 2014 - Global growth dynamics have weighed on domestic growth metrics - Coupled with significant currency weakness Currency weakness lower impact on South Africa versus peers - Brazil has lower weighting of foreign currency denominated debt - Remains its relative strength

SA per capita GDP lower than most EM peers

SOURCES: WorldBank, Trading Economics, Bloomberg, PSG Wealth research team

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Debts and deficits of EM peers

SOURCES: Trading Economics, PSG Wealth research team

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Emerging market credit

SOURCES: PSG Wealth research team, Bloomberg

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Credit default swap (CDS) spreads CDS spreads seem stretched for SA


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CDS spreads continued


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5 | Global growth challenges

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Global challenges • • • •

Global growth is projected to slow to 3.1% in 2016 before recovering to 3.4% in 2017 The forecast reflects a more subdued outlook for advanced economies following the June UK vote in favour of leaving the European Union (Brexit) Also reflects the weaker-than-expected growth in the US These developments have put further downward pressure on global interest rates, as monetary policy is now expected to remain accommodative for longer

SOURCES: IMF

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A decline in sovereign ratings •

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June 2016 S&P warned: “Sovereign downgrades are likely to outpace upgrades over the next 12 months.” “The outlook balance – positive minus negative outlooks – has dropped to -30 from the seven year high of -4 in 2015.” The table below shows the regional breakdown

SOURCE: S&P Global Ratings

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6 | Outlook for markets

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Market reactions after S&P decision

SOURCE: PSG Wealth research team, Oanda

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Market sentiment improved almost immediately The rand strengthened by 0.82% from Friday’s close The JSE was 0.94% stronger at 10h10 this morning than Friday’s close

Bond market response to move in high yield

SOURCES: PSG Wealth research team, S&P Global Ratings, Bloomberg

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7 | Bottom line

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Bottom line • •

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Saying we need a growing economy to avoid a future downgrade is too vague First we have to look at specific measures to get the economic outlook changed to positive, or at least stable The two most important factors are: 1. Government desperately needs to restore business confidence through more business friendly policies 2. We also need a stronger and stable exchange rate through stronger investor confidence to curb higher inflation and interest rates RMB/BER Business Confidence Index for SA declined to 38 in Q4 2016 from 42 in Q3 2016 - Confidence dropped in motor, retail and wholesale sectors - Confidence among manufacturers remained unchanged at depressed levels The results point to subdued growth in the second half of 2016 Investors in PSG Wealth Solutions should be assured that they are in good hands: - Their financial planning is done by the best financial planners available in South Africa - The investment process allows for tailor made solutions that align the investment objective with their investment goals. - The investment portfolios are managed by the best portfolio managers, both locally and offshore. We actively align our portfolios to protect against current risks, and to benefit from both current and expected future conditions

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