Fitch has decided against a downgrade of South Africa’s rating, providing some relief for the country’s struggling economy, but the global rating agency warned that weak growth potential and wide twin deficits continue to threaten credibility.

In a statement, released late on June 5, Fitch affirmed South Africa's long-term foreign and local currency Issuer Default Ratings (IDR) at BBB and BBB+, respectively, and reiterated its negative outlook on the ratings. Markets had feared a downgrade, as the agency had warned that a cut was possible, depending on economic growth prospects and the outlook for the public finances.

Now, Fitch said that although economic growth potential remains weak, the current account gap has started to narrow and the government has started to tighten fiscal policy, which should reduce the budget deficit.

The agency predicted the current account shortfall to shrink from 5.4% of GDP in 2014 to 4.5% in 2015 and 4.3% in 2016, helped by lower oil prices and weak domestic demand. It noted that the floating exchange rate, moderate foreign currency debts and overseas assets provide buffers against a 'sudden stop' of capital inflows, which are needed to finance the largest part of the current account deficit.

At the same time, preliminary data shows that the consolidated budget deficit fell to 3.5% of GDP in the 2014/15 fiscal year that ended March 31, below the Treasury’s latest projection of 3.9% made in February. Fitch expects it to widen slightly to 3.6% in the current fiscal year, below the Treasury’s target of 3.9%, as the government halted the ZAR15bn (0.4% of GDP) reduction in Unemployment Insurance Fund contributions. Fitch's baseline is for further reductions in the deficit to 2.9% of GDP in 2016/17, against a government target of 2.6%, and 2.5% in 2017/18, in line with the government’s target.

Regarding GDP growth, Fitch lowered its forecasts to 2.1% in 2015 and 2.3% in 2016, citing the ongoing electricity supply constraints, and underscored that this is well below estimates of growth potential of 3.5% - 4% before the global financial crisis. Growth is expected to pick up to 3% in 2017 as power shortages start to ease. The Treasury’s official forecast is for growth rates of 2.0% this year and 2.4% next year, while the country's central bank sees growth at 2.1% and 2.2%, respectively.

Fitch underlined the need for structural reforms to raise growth, and said that a continuing weak growth and a failure to boost growth potential, is one of the factors that could trigger a rating downgrade. It warned that some policy proposals under discussion, “such as parts of the mineral resources law, visa regulations, a minimum wage, amendments to the labour law, and land reform could have an adverse impact on growth, if implemented”. In addition, forthcoming wage negotiations in the gold and coal sectors could lead to further debilitating strikes or a sharp increase in wage costs.

Other potential negative rating triggers include a failure to reduce the budget deficit and stabilise the government debt-to-GDP ratio and/or a failure to materially narrow the current account gap.

An upgrade is unlikely in the near term, but the outlook could be raised to stable in case of an improvement in growth prospects and/or a reduction in the twin deficits.

South Africa's Treasury replied in a statement, released on June 6, saying that the issues raised by Fitch are getting the government’s attention at the highest level. It admitted that economic growth performance needs to be improved and assured that the implementation of priority reforms remains a key objective of the government. It said also that resolving the energy challenge is a priority and its plans to inject ZAR23bn into Eskom and convert a ZAR60bn loan into equity are firmly on track.

"Growth enhancing initiatives and programmes, targeting key sectors of the economy such as the energy sector are being implemented to support the country’s economic competitiveness," the Treasury said.

Of the other two major rating agencies, Moody’s rates South Africa at Baa2 - at the same level as Fitch, two notches above junk - but with stable outlook. S&P rates the country at BBB-, the lowest investment grade, with a stable outlook, and has said that it does not expect a change in the ratings in the next two years. However, it has also warned that Africa’s best developed economy should address weaknesses – like anaemic economic growth, a large current account deficit, high public sector wages, electricity shortages, and the financing of national power utility Eskom and other state entities - in order to avoid a junk status.