Last year was another challenging one for South Africa. Sluggish economic growth, political uncertainty, mounting fiscal pressure and weakening governance led two of the three largest credit rating agencies to push the country’s foreign currency rating below investment grade.
But there was a ray of hope towards year-end, and 2018 could well turn out to be a year of major political change in the country. Cyril Ramaphosa was recently elected the new president of the ANC, South Africa’s ruling party, which may pave the way for a return to economic prosperity.
Ramaphosa’s task of restoring the weak business confidence won’t be easy. The economy remains constrained by endemic corruption, high unemployment and a rigid labor market. Headwinds to reform persist, as shown by a nearly even split between supporters of President Jacob Zuma and the pro-Ramaphosa faction within the ANC’s National Executive Committee. And compromises will be needed to unify the party factions ahead of the 2019 general election, which could cloud the reform outlook and lead to market disappointments.
Despite this, the door seems open for more business-friendly policies and a sentiment-driven recovery. Ramaphosa delivered his first reform measures by replacing the majority of national utility Eskom’s board members with experienced financial and business professionals.
Meanwhile, he has been strengthening his position within the ANC. His allies won a clear majority of the seats in the National Working Committee, the body that oversees the day-to-day running of the ANC. And there is growing speculation that the party may decide that President Zuma must leave office before the end of his term in 2019.
The notion has not been officially endorsed by the party yet, but we think this may occur in the near term. A constitutional judgment on Dec. 29 held that the National Assembly had failed to hold Zuma accountable for a scandal involving the use of public funds, but he still faces multiple fraud allegations.
So we believe it is in the interest of the ANC to rebuild trust among its electoral base ahead of the 2019 general election. Removing Zuma from office now, more than a year before the start of the election campaign, should make it easier for the ANC to achieve this objective. Also, Ramaphosa is prompting the National Prosecuting Authority to investigate Zuma further.
Thanks to recent developments, we think prospects for structural reforms and the continuation of a sentiment-driven rally in South African assets have increased. Zuma’s exit may be followed by a cabinet reshuffle, greater efforts for fiscal consolidation and further governance changes at state-owned enterprises.
This should lower the probability of a downgrade to the country’s local currency bond rating by Moody’s in March – which could trigger capital outflows as South African local currency bonds would be removed from indices that are followed by large global institutional investors – although the risk remains high.
We remain overweight on South African credit and equities, and keep our recommendation for local currency bonds. On the currency side, we recently adjusted our three, six and 12-month forecasts for US dollar-South African rand to 12.0.
Disappointments related to Zuma’s exit and the reform momentum, a negative credit rating review by Moody’s and changes in global risk appetite remain key risks that we are monitoring.
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