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SA CREDIT RATINGS OVERVIEW

OCTOBER 2016

Reezwana Sumad

+2711 294 1753

ReezwanaS@nedbank.co.za

www.nedbank.co.za

Mohammed Yaseen Nalla, CFA

+2711 295 5430

mohammedn@nedbank.co.za

www.nedbank.co.za

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• The S&P methodology assigns scores

between 1 (strongest) and 6 (weakest) across

the five categories alongside.

• This is done by assessing the determining

factors, and adjusting the assessments based

on the adjustment factors alongside.

• The scores are averaged within two

subcategories and the matrix below is used

to provide an indicative rating.

• The indicative rating is given an uplift based

on supplemental data/evidence.

• A final foreign currency rating is achieved.

• The local currency rating is provided an uplift

based on monetary policy effectiveness and

local bond market activity

Source: Standard and Poors, Nedbank CIB

S&P SOVEREIGN CREDIT RATINGS METHODOLOGY

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Sources: Standard and Poors, Nedbank CIB

S&P SOVEREIGN CREDIT RATINGS METHODOLOGY

• Based on the S&P criteria, and both the

qualitative and quantitative assessment

thereof, a foreign currency rating is derived

from the matrix alongside.

• There remains some latitude in terms of

potential uplift to the above mentioned

rating in the event that qualitative factors

suggest that such an uplift is warranted.

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Our assessment of key risk flags (since June to date)

indicates that performance has been mixed across the

board.

While there has been progress on some metrics, this is

marginal at times and may not yet indicate a sustained

shift.

Certain macroeconomic indicators have improved but this

improvement is seen as cyclical in some respects, and as

such, insufficient to inform trend changes.

Any potential deferral in a credit downgrade should not be

construed as an incentive to ease off the prioritisation of

structural reforms

EVOLUTION OF KEY RISKS – JUNE 2016 TO PRESENT

Source: Nedbank CIB

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There is much concern over what a downgrade may entail.

At present, the exclusion criteria for the major bond

indices implies some buffer on the S&P ratings, given the

fact that local currency (LC) ratings are two notches above

foreign currency (FC ratings).

JP Morgan Global Aggregate Bond Index

• EM external debt instrument eligibility is determined by

the HIGHER rating of either S&P or Moody's.

• Currently Moody's is one notch above S&P, implying a

low risk of exclusion

CITI World Government Bond Index

• Remain above BBB- (S&P) or Baa3 (Moody's) for

sovereign LC ratings.

BOND INDEX EXCLUSION (RATINGS) CRITERIA

Source: Nedbank CIB, S&P, Moody's, Fitch, JP Morgan, Citi

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Nedbank view:

• Institutional - Generally effective policymaking and public finances, but potentially destabilising socioeconomic

challenges remain.

• Economic: SA is currently on the cusp for a lower GDP-per-capita score. Although improvements would have

been noted on the back of a strong rand recently, this will likely be viewed as cyclical. Economic conditions

remain vulnerable to external shocks, while potential growth remains low. A structural trend shift will need to

be observed to inform a change in view.

• External: Despite having a large and liquid currency market, external indebtedness remains high. Current

account receipts are unlikely to maintain the recent favourable trend due to sluggish global demand.

• Fiscal: Fiscal performance and flexibility remain weak. Government debt levels have risen by 6% of GDP, on

average, over the last five years. Added to this is the shortfall in basic services like healthcare and education.

On the debt side, even though the government debt level is acceptable (45% of GDP in 2015), interest

expenditures have averaged 12% of total revenues over the past five years.

• Monetary: SA's monetary sector remains a key strength, with the SARB's credibility, effectiveness ,

independence and inflation targeting policies effective.

OUR CURRENT ASSESSMENT INDICATES SOME MARGINAL IMPROVEMENTS

Sources: Nedbank CIB, IIF

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• The rule of thumb is that approximately 18 months is a reasonable length of time from an outlook change to an actual downgrade. However any material adverse development may

catalyse a more aggressive downgrade cycle, or in extreme circumstances, an out of cycle change (which can occur at any time outside the normal review dates provided).

• An example of these timeframes would be Brazil which was downgraded to BBB- in March 2014, and thereafter downgraded to sub-investment grade BB+ in September of 2015 (18

months). Thereafter, a further downgrade to BB was announced in February 2016 (six months) as negative growth dynamics were compounded by significant increases in political risk.

• It has been around 28 months since SA’s previous S&P downgrade to BBB- (June 2014) and ten months since the outlook changed to negative. There has been a significant

deterioration in growth rates which can be partially attributed to cyclical as well as structural factors. The latter is of more material consequence to a sovereign’s ability to repay its

debt.

• Since the start of the current ‘hiking cycle’ in EMs, South Africa has been relatively more muted in only having experienced 200bps of hikes. This indicates that monetary policy, while

observing the ideals of inflation targeting and price stability, has not been overly restrictive.

• This compares favourably to Russia and Brazil, both with over 450bps of hikes, which has exacerbated the growth downturns in those economies.

Most recent SA ratings activity:

• S&P downgrades outlook to negative from stable (December 2015).

• Fitch downgrades credit rating to BBB- from BBB (December 2015) and changes outlook to stable.

• Moody's downgrades November 2014 to Baa2 and affirm negative outlook in May 2016.

Source: Bloomberg, S&P, Nedbank CIB

CASE STUDY – EMERGING MARKETS

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O

Cumulative

move

Current

rate CPI y/y

S&P

rating

5y CDS

spread

Brazil 50 25 25 25 50 50 50 50 50 50 50 475 14.25 8.97 BB 275

India 25 -25 -25 -25 -50 -25 -25 -150 6.25 5.3 BBB-u 131

Mexico -50 25 50 50 50 125 4.75 2.73 BBB+ 160

South Africa 50 25 25 25 50 25 200 7.00 5.9 BBB- 246

Turkey 550 -50 -75 -50 -50 -25 300 7.50 7.28 BBu 250

China -40 -25 -25 -25 -25 -25 -165 4.35 1.3 AA- 105

Russia 150 50 50 150 100 650 -200 -100 -150 -100 -50 -50 -50 450 10.00 6.4 BB+ 223

Thailand -25 -25 -25 -75 1.50 0.38 BBB+ 86

Indonesia 25 -25 -25 -75 -25 -125 6.50 3.07 BB+ 150

Hungary -75 -45 -120 0.90 -0.1 BBB- 115

Legend: Indicates upgrade Indicates downgrade Stable outlook Negative outlook

2014

EM Policy moves since Jan 2014 (change in basis points)2015 2016

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• Hungary was recently upgraded by S&P back into investment grade, at BBB- (stable), after remaining in

speculative grade for five years. The upgrade came as a result of a rebound in growth, fiscal prudence

and budget discipline. Further, the country's external financial profile has improved markedly, while the

immunization of the sovereign debt profile from foreign-currency volatility also played a role .

• Factors leading to the downgrade into junk status in 2011:

• IMF-led bailout in 2008 to avoid a default.

• Deep recessions in 2009 and 2012-2013.

• Ruling party ousted the Chief Justice of the Supreme Court.

• Narrowed the jurisdiction of the Constitutional Court.

• Ruling party wrote a new constitution.

• A new media regulator was created.

• Government takeover of the Monetary Council.

• 'Nationalisation' of private pension fund assets.

• Plans to merge the financial regulator and the central bank.

• Overall Institutional effectiveness was undermined.

• Factors leading to the upgrade into investment grade this year:

• Better budget discipline bolstered public finances - budget deficit below 3% of GDP, budget debt as a % of

GDP declining.

• Stronger economic performance - no recession since 2012.

• Lower vulnerability to exchange rate volatility - household Swiss franc-based mortgages converted to

forint.

• Declining foreign-currency denominated government debt (26% forecast for 2017 vs. 52% in 2011).

CASE STUDY – HUNGARY’S RETURN FROM SUB-INVESTMENT GRADE

Source: Nedbank CIB, Bloomberg

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• Marginal positive developments in the short-term, mainly on the economic front, may help SA avert a downgrade in December.

• Institutional assessment remains neutral, while monetary assessment is a key strength, keeping SA in investment grade.

• Emerging market case studies show a marked deterioration in more than one category (typically Institutional and Economic) over a short

space of time, before a downgrade to junk status tends to materialise.

• Risks to the ratings outlook are to the downside, unless MTBPS can provide some uplift to ratings agencies outlook.

• For now, assuming a reasonable MTBPS, we anticipate no change in the rating, with the negative outlook maintained at the December

review.

CONCLUSION

Source: Nedbank, S&P, Moody's, Fitch, JP Morgan, Citi

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