Loss of IG Rating and Troubles at Eskom Dominate Discussion at EMTA’s Forums in South Africa

EMTA held its inaugural events on the African continent with Forums in Johannesburg and Cape Town, South Africa. The events were held on Tuesday, November 19, 2019 and Wednesday, November 20, 2019, re­spectively, with each drawing a crowd of approximately 100 market participants. Standard Bank hosted both gatherings, with the additional support of Goldman Sachs in Cape Town.

Panelists focused on the outlook for the South African economy at both meetings. A wide variety of subjects were discussed, including the potential effects of the country losing its last IG-rating, the prospects for the troubled Eskom utility corporation, the inflation outlook and SARB interest rate policy.

Elna Moolman (Standard Bank) moderated panels in both cities. She initiated each session with a discus­sion of the country’s 2020 budget and fiscal policy. In Johannesburg, Adriaan Du Toit (Alliance Bernstein) ob­served that, historically, it has proven difficult to make meaningful inroads into reducing the country’s bloated public sector wages, and “my expectations for the bud­get are relatively low…I don’t think it will be enough to stabilize the markets or the country’s ratings.” Zeyn Ismail (Stanlib) did not anticipate any major tax policy changes to be announced, and speculated that any move to raise taxes would merely lead to increased tax avoidance and evasion. Carmen Nel (Matrix Fund Managers) warned that, should debt/GDP ratios con­tinue to rise, South Africa would either become more vulnerable to foreign inflows, or would need to pay a higher cost for domestic funding.

In Cape Town, Nishan Maharaj (Coronation Fund Managers) argued that it was now up to politicians to make the hard choices in reducing expenditures. Mokgatla Madisha (Sanlam Investments) maintained that a VAT hike was possible to address the revenue side.

Moolman brought up on-going speculation that South Africa could lose its last-remaining IG rating in early 2020. At the Johannesburg event, James Turp (Absa Asset Management) commented that, while the market “widely expects” a downgrade by Moody’s to junk level, investors should also re­member that Fitch Ratings has the credit on “negative outlook” and may downgrade the credit one additional notch further into junk territory. He concluded that, once the IG rating is lost, “it will be difficult to get it back for the next 10-12 years.”

While panelists in both cities largely concurred that the downgrade appeared to be largely priced in, Turp predicted a possible knee-jerk sell off, which could be used as an opportunistic buy. In Cape Town, Madisha ventured that as much as $5 billion in outflows could occur should South Africa lose its rating and be removed from the WGBI, while pointing out that this could be offset by new buyers attracted by increased yields.

Brian Kahn (Investec Asset Management and former SARB official) underscored that, although Moody’s down­graded the outlook to negative, the report read more like a change to a 3-month “negative watch,” not a longer term 12-18 month negative outlook, meaning that a downgrade was likely by March 2020. “The best case is that we are able to claw back some budget credibility in February, and I’m not so confident we can,” he stated. Kahn stressed that, the loss of the IG rating could further stymie progress--“once a downgrade occurs, the sword overhanging politicians is gone, and it will take pressure off.”

Moolman asked speakers how they would turn Eskom around if given the opportunity. “The fact they have a new CEO is a positive because it adds direction, even if the particular CEO isn’t,” argued Ismail. While recog­nizing it may be “easier to say than do,” Nel pondered whether defaulting on un­guaranteed debt might add more security to guaranteed debt, and a “shock factor allowing for more relevant bond prices.” She followed up with possible alterna­tives including a bail-in, or possible debt/equity swaps. Ismail saw possible infra­structure improvements if a clear policy framework were provided. Turp empha­sized that a reprofiling of Eskom debt was essential to “bring to heel” those who bought the utility’s debt on the expecta­tion of a sovereign guarantee. Moderator Moolman herself mused whether some power stations could be sold.

At the Cape Town panel, Maharaj proposed reorganizing Eskom’s debt, creating three different entities, re-allocating its work force, and listing a minority stake in the company, while he acknowledged that a wage freeze would not be enough. Madisha discussed the need to improve collection in a country “with a culture of non-payment for services…and I don’t see that being changed in the next 3 to 5 years.”

Turning the effects of global factors on the South African economy, Turp envisioned a reduction in US-China trade tensions, which he saw as being of mutual interest. Du Toit saw the situation as ebbing and flowing, but that, “populism will hurt the global economy.” Popular protests in South Africa along the lines of what had oc­curred in Hong Kong, Chile, etc. could not be ruled out, in his view.

Addressing the disappointment with “Ramaphoria,” Nel stated that, “the best case last year was for incremental moves by the President, but, even if that was your view, you would be disappointed…it’s not quite clear if Ra­maphosa has the political capital, and thus far, in negotiations, he has only given.” She added that regulations in South Africa benefitted large businesses, and that small and medium enterprises had to encouraged, in order to generate greater competition. Turp, when asked if he could add an optimistic note to the panel, compared the greater attention paid to negative stories, such as the disappointing budget, to the gradual reform progress. “Once there is traction on the road to recovery, that’s the time to go in,” he advised.

Speaking a day before an anticipated SARB rate decision, most speakers believed the Bank should, and would, cut rates. “They have no strong argument not to cut rates,” affirmed Kahn, who cited “constant” surprises to inflation on the downside…as well as growth that also didn’t meet expectations. Still, he estimated the odds of a rate cut as only 50/50. [The SARB did not cut rates at its meeting shortly after the Forum, but subsequently cut rates in January 2020.]

An additional panel took place in Cape Town moderated by Andrew Matheny (Goldman Sachs), who began by polling his speakers on growth. “The business sector is exceptionally gloomy in its growth prospects…there is no demand at all,” lamented Allan Gray’s Sandy McGregor. Increased tourism and a revived platinum industry could be positive factors, while a weaker rand alone would not drive growth, in his assessment. Du Toit called attention to a GDP per capita ratio that has been contracting for years, with unemployment and unequal income distribution greater than in countries where popular protests had recently occurred. Protectionism was harming the global economy, and that wouldn’t help South Africa’s growth, he added.

“We need some bold measures to bring back business confidence,” declared Rashaad Tayob (Abax Invest­ments), who specified that liquidating South African Airways should be considered. Tayob expressed concern that the government still didn’t recognize the private, not public, sector as the driver of growth, and didn’t understand the sense of urgency. “The government may not even need to add gas to the development of new sectors, it may just need to stop put­ting the brakes on them,” he concluded.

While most panelists concurred in the benefits of rate cuts, Jean-Pierre du Plessis (Laurium Capital) reminded speakers that, “the SARB has been quite clear; they said structural re­forms were needed, and that they couldn’t do all the heaving lifting themselves.” Du Toit referenced the SARB’s credibility in international markets, and highlighted that there was a “cost to sitting on the sidelines…when the economy is weak. There is a lot of room for cuts.”

Du Plessis referred to the loss of government credibility with its most recent budget, and expected the next one would be more aggressive. In his analysis, President Ramaphosa and Finance Minister Mboweni “have great ideas, but the question is implementation; the elephant in the room is the wage bill; is there the political will to address that?”

Matheny also led a discussion of Eskom’s troubles. McGregor stressed the importance of bondholder confi­dence in management. Reducing “grossly overstaffed” labor rolls was a political decision, and he feared the government was in a state of drifting, with politicians thinking a muddle through scenario was possible, and avoiding drastic action. As a result, “we will continue to fund Eskom, and there will continue to be issues for the South African budget.” In his view, a default would be a “total disaster,” which would dry up funding for quasi-sovereigns, with international default lawyers “all jumping on planes.”

Tayob agreed that strong management was more important than a corporate reorganization. He advised man­agement to focus on a single goal, rather than numerous goals which often translated into nothing being ac­complished. Du Toit wasn’t sure of the solution to Eskom, “…but management also doesn’t know at this point in time.” He cautioned that, “bondholders will be quite demanding if it gets to potential restructuring discussions.”

The panel concluded with Matheny asking speakers whether the global backdrop was a tailwind or a headwind for South Africa. Tayob warned that, “the market is giving us room to entrap ourselves in a bond problem…there is zero discipline in the market, look at the Argentina century-bond.” DuPlessis saw the backdrop as benign; “a lot of our problems have been of our own making, and we have been allowed to get into these problems because of foreigners buying our bonds.” Du Toit characterized South Africa as a highly unique country, with which it was hard to find comps; “we are sort of in a no-man’s land.”