Unless the South African government can rid itself of rent extraction at state-owned companies like Eskom, SAA and Transnet, the country will likely be fully ‘junked’ by the second quarter of 2018.

Research analyst at Nomura, Peter Attard Montalto, has warned investors to keep a close eye on the goings-on at South African parastatals, which have massive funding and governance issues, and are an extreme liability on the fiscus.

Despite claims from companies like Eskom and SAA that they are working to be less of a burden on National Treasury, Attard Montalto believes that the implicit exposure of these companies to the country’s sovereign is much higher than stated.

“Guarantee policy is also far from clear, especially at Eskom,” Attard Montalto said.

Eskom recently stated in its annual report that it wants to ‘release’ R105 billion of government guarantees. The wording of the statement implied the sovereign’s exposure would fall in absolute terms, “but this turns out to be simply a plan to not take up budgeted guarantees in the future as a result of the lower cost differential between a downgraded sovereign and Eskom unguaranteed,” he said.

In reality, Eskom’s annual report warns that more guarantees could be needed if such unguaranteed credit is not available.

“Indeed, the report goes further to state that Eskom has asked for a future R84 billion of guarantees (within its existing guarantee framework that has now been extended) to 2023 to cover funding it needs in the coming years,” Attard Montalto said.

SAA, too, faces funding woes following a recent bailout, and reports that the airline is effectively bankrupt, with billions of rands needed to keep operating, and to pay off debts.

The analyst added that there is also currently no public transparency on guarantees for the BRICS development bank and sovereign bilateral loans, which makes Nomura believe that there are strong ‘political’ guarantees that can be treated as “strong implicit quasi-guarantees” at SOEs.

Amid these funding concerns, there are also fears from investors around continued claims, reports and investigations regarding state capture and rent extraction at state companies.

The real question for investors, the analyst said, is whether the amount of rent extraction going on at these SOEs moves up, down or sideways.

“Until it starts falling we don’t believe parastatal risk to the sovereign can be said to have eased.”

Ratings agencies are not blind

According to Attard Montalto, because of these issues at SOEs – risks, governance problems, funding restraints, rent extraction – they are becoming an increasingly important metric for ratings agencies.

Fitch currently has South Africa in sub-investment grade (“junk”) on both the country’s local and foreign debt – but S&P Global only has that rating for the country’s foreign debt (which only makes up around 10% of debt). Moody’s still has South Africa one notch above junk on both ratings.

Alongside low growth and lack of fiscal space as well as a lack of structural reform in South Africa, issues at SOEs could push South Africa to full junk as early as November 2017, Attard Montalto said.

However, the most likely point in time would be after the February budget speech, meaning a 2nd quarter 2018 shift.

If all ratings agencies boot South Africa out of investment grade, it loses its place in the World Government Bond Index (WGBI), which would immediately push as much as R120 billion in foreign investment out of the country.

“We see a strong chance of South Africa being removed from the WGBI in Q2 2018 at the earliest, which would result in around $8-9 billion of outflows from the local bond market,” he said.

Attard Montalto said that investors have “noted” plans by SOEs to reform, but added that investors are increasingly unlikely to give benefit of the doubt to turnaround strategies until they deliver results.

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