US embassy cable - 04PRETORIA3501

UNCLAS SECTION 01 OF 03 PRETORIA 003501 
 
SIPDIS 
 
DEPT FOR AF/S/JDIFFILY; AF/EPS; EB/IFD/OMA 
USDOC FOR 4510/ITA/MAC/AME/OA/DIEMOND 
TREASURY FOR OAISA/BARBER/WALKER/JEWELL 
USTR FOR COLEMAN 
LONDON FOR GURNEY; PARIS FOR NEARY 
 
E.O. 12958: N/A 
TAGS: EINV, EFIN, ETRD, BEXP, KTDB, PGOV, SF 
SUBJECT:  SOUTH AFRICA'S CREDIT RATINGS 
 
 SUMMARY 
 ------- 
 
 1.  (U) From the end of June through mid-July 2004, 
 several research and credit agencies (Fitch, Moody's 
 Ratings, Standard & Poor's, and the Economist 
 Intelligence Unit) presented to Johannesburg 
 audiences their outlook and ratings for Sub-Saharan 
 Africa and South Africa in particular.  The 
 conclusions of all four agencies were similar.  All 
 agreed that prudent fiscal and monetary policies 
 fueled expectations of higher economic growth in 
 2004 and 2005; however, medium term challenges serve 
 as constraints to long-term growth.  If this growth 
 materializes and the rand stays strong, South 
 Africa's credit rating may improve.  In addition, 
 the November 2004 revision of gross domestic product 
 may show actual growth to be substantially higher 
 than previously thought as a result of improved 
 manufacturing and services data being incorporated 
 into GDP.  All agencies noted longer-term structural 
 problems that might inhibit improved credit ratings. 
 Currently South Africa is rated on a par with other 
 middle income countries but their peers do not face 
 the same unemployment, income inequality, poverty 
 and health problems that South Africa does. End 
 Summary. 
 
 Similar Views on South African Perspectives 
 ------------------------------------------- 
 
 2.   (U) Ratings agencies and research firms rate 
 South African strengths and weaknesses similarly. 
 Fiscal and monetary policies are deemed prudent as 
 the budget deficit is low, foreign debt is low, 
 inflation is under control, and the current account 
 balance is affordable.  All agencies commend the 
 higher economic growth, with GDP growing 2.8 percent 
 between 1994 and 2003 compared to 1.5 percent growth 
 in the 1980s.  All cite the same constraints facing 
 South Africa in the medium term, mainly structural 
 economic weakness against a background of 
 inequality.  These include the economic impact of 
 HIV/AIDS, low levels of savings and investment, 
 rigidities in the labor market.  Ratings agencies 
 cite the low levels of reserves as an impediment to 
 an upgrade in credit ratings.  However, Moody's 
 Credit Ratings Officer thought that a ratings review 
 of South Africa might be in order if revised GDP 
 growth turns out to be significantly higher when the 
 November 2004 GDP revision is due. 
 
 Fitch Ratings 
 ------------- 
 
 3.   (U) Fitch Ratings emphasized improved growth 
 prospects in Sub-Saharan Africa, for 2004 and 2005, 
 4.5 percent and 4.7 percent, respectively, compared 
 to 2.7 percent in 2003.  In March 2004, Fitch again 
 rated South Africa's long-term foreign currency 
 "BBB", and its long-term local currency at "A minus" 
 with a stable outlook, unchanged from its May 2003 
 ratings.  Other peer countries in this category 
 include Thailand and Tunisia.  Countries rated one- 
 notch above at BBB plus include Latvia, Lithuania, 
 Malaysia, Poland and Slovakia. Countries one notch 
 below include Croatia and Mexico. 
 
 4.   (U) Fitch cited improvement in the public and 
 external debt ratios, falling inflation, and the 
 elimination of the net open foreign position leading 
 to an improvement in South Africa's liquidity 
 indicators as positive developments.  Low 
 investment, social and economic inequities, and 
 lower growth than peer countries were factors on the 
 negative side.  Fitch analysts noted that South 
 Africa and Nigeria were the engines for growth in 
 Sub-Saharan Africa and that South African firms had 
 been rapidly increasing their investment in the rest 
 of Africa.  One issue raised is whether the rapid 
 increase of South African investment in 2003 is 
 sustainable, given the relatively small domestic 
 markets in other African countries. 
 
 Moody's Ratings 
 --------------- 
 
 5.  (U) Moody's feels that its optimistic 
 perspective in 1994 was vindicated.  Since 1994, 
 Moody's has raised its "Baa3" country rating to Baa2 
 in 2001, and in February 2003 assigned a positive 
 outlook to its Baa2 long-term foreign currency 
 ratings.  Credit Ratings Officer Kristin Lindow 
 suggested that South Africa might warrant another 
 review if it turns out that past growth was 
 seriously underestimated because incomplete coverage 
 of both the manufacturing and service sectors in the 
 national income accounts.  Faster actualized growth 
 may improve investor perceptions towards viewing 
 South Africa as a fast growing market with high 
 investment potential. 
 
 6.  (U) The reasons for the most recent credit 
 outlook upgrade to positive are the similar for 
 Moody's as other ratings agencies.  Falling 
 inflation, low domestic and foreign debt, lower 
 interest rates, and improving external liquidity 
 made South Africa a better credit risk.  On the 
 negative side, Moody's May 2004 Analysis also lists 
 the serious economic and social challenges ahead, 
 namely managing HIV/AIDS pandemic, reducing income 
 disparities, making inroads on unacceptably high 
 levels of unemployment, and increasing investment in 
 a climate compounded by low domestic savings and low 
 foreign direct investment, and exchange rate 
 volatility.  One distinguishing characteristic of 
 Moody's analysis is the emphasis it placed on 
 political developments, including mentioning the 
 uncertainty clouding the next five years over the 
 succession question in the African National 
 Congress.  Since foreign direct investment is low, 
 Kristin Lindow's views are that the source of higher 
 South African growth has to be domestic investment. 
 Because foreign portfolio investment far exceeds 
 foreign direct investment, its capital flows are 
 more volatile and short-term oriented.  Moody's does 
 not foresee a change in the distribution of South 
 African foreign investment. 
 
 7.  (U) Lindow also believes that the South African 
 Reserve Bank should increase its foreign reserves. 
 She points out that South Africa's $10 billion in 
 reserves is well behind the $20 billion in reserves 
 in its peer group.  On the bright side, commercial 
 bank foreign assets have grown from $7.7 billion at 
 the end of 2002 to $16.3 billion by the end of 
 April.  Moody's counts Malaysia, Saudi Arabia, 
 Bahrain, Mexico and India as peer countries. 
 
 Standard & Poor's Ratings 
 ------------------------- 
 
 8.   (U) In June 2004, Standard and Poor's rated 11 
 African countries at the request of United Nations 
 Development Program, including South Africa.  Of the 
 11 countries, Tunisia and South Africa received the 
 highest long-term foreign currency rating at "BBB". 
 South Africa received the most improved rating since 
 its initial 1994 rating of "BB", reflecting progress 
 in fiscal and monetary reforms.  Standard & Poor's 
 includes Mexico, Tunisia, Thailand, Oman, China and 
 the Slovak Republic as South Africa's country peers. 
 South Africa's socioeconomic problems of high 
 unemployment, income and land distribution 
 inequalities, skills shortage, high crime rates, 
 HIV/AIDS pandemic, and low economic growth are more 
 severe than those faced by its peers.  These 
 challenges are counterbalanced by better fiscal and 
 monetary policies and transparency in budgeting and 
 planning compared to peer practices. 
 
 Economist Intelligence Unit's Analysis 
 -------------------------------------- 
 
 9.  (U) The Economist Intelligence Unit (EIU) 
 produced a South African country report in June 2004 
 primarily expecting an increase in growth over the 
 next two years compared to 2003's 1.9 percent due to 
 robust foreign growth, further strength in domestic 
 demand and growth in tourism.  Increasing foreign 
 demand will help boost exports, but rising imports 
 will lead to a gradual reduction of the trade 
 surplus and a modest deterioration of the current 
 account deficit to 1.7 percent of GDP in 2004 and 2 
 percent in 2005.  EIU's forecast is for a weaker 
 rand in 2005 as interest rate differentials begin to 
 subside with the global trend towards higher 
 interest rates.  The EIU offers economic analysis 
 but does not rate countries. 
 
 10.  (U) The EIU's country report provides more 
 detailed coverage of both the political, industrial 
 and financial sectors than the ratings agencies; 
 however, the focus is short-term, with 2005 as the 
 latest forecast year.  EIU considers rigid labor 
 legislation and regulations concerning employment as 
 a major obstacle to more rapid job creation in the 
 private sector and doubts that GDP growth rates will 
 reach 5 to 6 percent.  It cites a recent study by a 
 research group chaired by Roger Baxter of the 
 Chamber of Mines concluding that the low level of 
 domestic investment is the major reason for 
 lackluster growth rates.  The study argues that 
 local business fails to invest because the cost of 
 capital is 8.5 percent when the average real rate of 
 return from listed companies is 8.6 percent.  The 
 high cost of capital was the result of high real 
 interest rates, volatile inflation and exchange 
 rates, high corporate tax rates, and the perceived 
 risk of doing business in Africa. 
 
 Comment 
 ------- 
 
 11.  (U) All analyses point to the same past fiscal 
 and monetary successes combined with serious mid to 
 long-term challenges that South Africa must overcome 
 before it qualifies for higher ratings.  The private 
 sector will be the source of new jobs; however, 
 skills, labor flexibility, and investment would have 
 to be seriously improved before South Africa 
 experiences high enough growth to reduce poverty and 
 unemployment.  Nevertheless, South Africa remains 
 the engine for Africa's growth; the IMF estimates 
 that every 1 percent increase in South Africa's 
 growth, sustained over five years, will add between 
 0.4 and 0.7 percent to African growth.  South Africa 
 will have to increase domestic investment, upgrade 
 skills, attract more foreign investment, and provide 
 a more flexible labor environment to change the 
 views of these ratings agencies in a favorable way. 
 MILOVANOVIC