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Summary of South Africa: Positive Feedback Loops

Core Content

This document provides an analysis of South Africa's economic and financial outlook, focusing on the potential for Moody's to affirm the country's sovereign rating on 23 March 2018 and the implications of this for the local currency (ZAR) and bond markets. It outlines the positive developments that have occurred since late November 2017, including political and economic reforms, which are expected to support the country's financial standing and encourage further monetary easing by the South African Reserve Bank (SARB).

Main Points

• Moody's Rating Outlook:
  Moody's is unlikely to downgrade South Africa's sovereign rating on 23 March. The agency is expected to affirm the 'Baa3' rating with a negative outlook, removing the review for downgrade.

• Positive Developments:

  • Cyril Ramaphosa became president of the ANC and the country.
  • Reforms were made to Eskom's board.
  • A positive budget policy statement marked a return to fiscal consolidation.
  • A well-received cabinet reshuffle included strong appointments to key portfolios.

• Positive Feedback Loops:
  The combination of lower external vulnerabilities, soft inflation, and the likelihood of rate cuts is expected to create positive feedback loops. These loops are likely to support the rand and the domestic bond market in the near to medium term.

• Expected Rate Cuts:
  The SARB is expected to cut interest rates by 25 basis points on 28 March, with a further cut likely in May. The currency has appreciated by about 8% against the USD and over 3% in trade-weighted terms since the January MPC meeting.

• Inflation Outlook:
  Headline inflation is expected to slow to 4.1% year-on-year in February, mainly due to lower fuel prices and contained food inflation. The SARB is likely to revise its medium- to long-term inflation forecasts downward due to the stronger rand.

• GDP Growth Forecast:
  The document forecasts 2.0% GDP growth for 2018, citing a strong rebound in business confidence, with the strongest quarterly improvement in seven years.

• Moody's Outlook:
  Despite the positive developments, the outlook for South Africa's sovereign rating is expected to remain negative. Moody's will likely require further improvements in growth prospects, institutional capacity, and debt metrics before it changes the outlook to stable.

• Policy Actions and Growth:
  The government's handling of key policy issues, particularly land expropriation without compensation, will be crucial in determining whether Moody's will upgrade its outlook in 2019. Other priorities include finalising mining policy and improving governance at state-owned entities.

Key Information

• Currency Appreciation:
  The ZAR has appreciated significantly against the USD and in trade-weighted terms since January, which has helped reduce inflationary pressures and improve external balance.

• Inflation Data:
  February CPI is expected to slow to 4.1% year-on-year, with the core CPI remaining unchanged at 4.1%. This is likely to support the SARB's case for rate cuts.

• Balance of Payments:
  The Q4 2017 balance of payments is expected to show a current account deficit of 2.0% of GDP, which is a marked improvement from the previous quarter.

• Market Reactions:
  South African CDS has outperformed other emerging markets, indicating market confidence in the rating outcome and the economic environment.

• Charts and Data:

  • Chart 1: Shows Moody's as the only investment-grade rating for South Africa.
  • Chart 2: Highlights the "Ramaphosa effect" on business confidence.
  • Chart 3: Indicates that CPI is likely to remain below 5.0% in 2018 and 2019.
  • Chart 4: Depicts the SARB's revised currency assumptions.

Conclusion

The document suggests that South Africa is on a path to avoid a Moody's downgrade, supported by political and economic reforms, improved external balances, and lower inflation. This is expected to create positive feedback loops that support the rand and the local bond market, potentially leading to further rate cuts. However, the outlook for the sovereign rating is likely to remain negative, and the government's ability to manage key policy issues will be critical in determining future rating changes and economic stability.