Presenter: Lindsay Williams Guest(s): George Glynos

International agency Fitch Ratings upgrades South Africa’s long-term foreign currency rating to BBB+ from BBB, and short-term is upgraded to F2 from F3 - the third vote of confidence from overseas ratings agencies in recent times. With Veronica Kalema from Fitch Ratings, and George Glynos from Econometrix Treasury Management

LINDSAY WILLIAMS: Veronica, what does BBB+ mean, and why did SA get upgraded by Fitch?

VERONICA KALEMA: BBB+ is part of the rating scale - it’s moving up obviously, it’s better than BBB. The reason why South Africa has been upgraded is growth performance has exceeded earlier expectations - this time last year expected growth was 3% to 3.5% over the medium-term, - now it’s more like 4% over the medium term.

LINDSAY WILLIAMS: That growth number you talked about - we had a quarter on quarter GDP growth number of 4.8% a couple of days ago - is that something Fitch was waiting for, in order to effect this upgrade?

VERONICA KALEMA: No, not at all. That basically confirmed our view, but no, we weren’t waiting for that.

LINDSAY WILLIAMS: Apart from growth, what were the other criteria in your decision?

VERONICA KALEMA: There has also been a substantial improvement in South Africa’s external indicators - due to a sizable build-up of reserves over the past year, so that international liquidity is very comfortable, and it is relative to South Africa’s rating peers - South Africa looks right in line with its rating peers.

LINDSAY WILLIAMS: So we’ve got GDP growth, we’ve got external liquidity - what about other things like inflation and political stability? Does that also come into your equation?

VERONICA KALEMA: All those feed into the growth story - inflation is low therefore interest rates are low - therefore that is supportive of growth. Politics is stable - so that is supportive of the continuation of the policy framework.

LINDSAY WILLIAMS: We are still an emerging market - where do we compare? If you could look at another merging market that Fitch covers, who would we be comparable with at the moment?

VERONICA KALEMA: At the moment at BBB+ you would be comparable with Poland and Thailand, and you would be a notch below countries like China, Israel and some of the Eastern European countries like Hungary, Czech Republic and Slovakia - so it is pretty good.

GEORGE GLYNOS: Veronica, there’s been a move upwards in the ratings, and you’ve listed a number of positives here in South Africa’s performances so far - I just wanted to know from you what you believe would be the next significant step that South Africa needs to take to increase its credit rating quite a bit further?

VERONICA KALEMA: The countries I’ve just mentioned - actually they have very strong numbers, so if South Africa improved its numbers substantially that’s one of the things it could do. Another thing it needs to do is have even higher growth - because of its relatively more complex socio-economic problems that need to be addressed. So the numbers need to improve quite substantially - they are moving in the right direction, but the numbers of the other countries are quite strong, and then also higher growth.

LINDSAY WILLIAMS: Talking about growth, we look at China and we look at 8%, 9% and 9.5 % GDP growth - are you talking about those sort of numbers? The SA Reserve Bank Governor is targeting 6% GDP growth - if we got up to those sort of numbers would we go from BBB+ to A for example?

VERONICA KALEMA: China is growing very fast - South Africa doesn’t need to get to 8%, but sustained 6% growth would in terms of bringing all the numbers down, and resolving all these socio-economic problems.

LINDSAY WILLIAMS: Looking at the impact that this upgrade will have on the international investment community - Fitch obviously broadcasts this, and you go to your clients and say: "South Africa is now BBB+" Does this move us into the next bracket of foreign direct investment for example - does that mean certain companies, certain countries, certain fund managers can now look at us in a different light, and say: "Now I can allocate extra money to South Africa, or new money to South Africa?"

VERONICA KALEMA: I think South Africa in the BBB category - you know it’s still in the same category, but what it does is it reduces the cost of international borrowing by the government and companies, and because it helps improve confidence it’s positive for foreign direct investment, and other sorts of investment.

LINDSAY WILLIAMS: George, from your point of view it’s really a follow-on from the other ratings agencies Moody’s and S&P - but it’s still a thumbs up! It’s still a positive step towards South Africa’s economic growth?

GEORGE GLYNOS: Very much so, and as you said it’s a follow-on. I think it describes the good news story that South Africa is experiencing at the moment quite well. I’m fairly optimistic that we’re going to have more such upgrades in the future - if government can step up to the plate in terms of their service delivery, and the infrastructural spending that they plan to undertake for the next five years leading up to the 2010 World Cup. I think growth of around 6% is achievable - government does need to streamline some of its processes, but should that take place, and we maintain a low interest rate environment - that becomes more investor friendly ironically because of the upgrades that we’ve been getting from the credit ratings agencies. I think it’s a good news story that’s set to continue.

LINDSAY WILLIAMS: It is a good news story, but it was expected - here is a comment from one economist who shall remain nameless. He says: "I think it has been built into bonds expectations - although it could have a short-term positive effect on the bond market." Completely wrong of course - because the bond market took a bit of a smack today, and that’s because of the PPI data following yesterday’s CPI data. Maybe you could just run us through that PPI number - quite a big jump!

GEORGE GLYNOS: Quite a big jump - naturally oil and the rand price of oil played a significant role in that. There always tends to be a bit of a lagged affect between when we see the rand weakening, and when it starts to have a material impact on inflation - clearly here I’m talking about the weakness we saw in the rand that materialised through May. I believe that’s one of the reasons why we saw the imported component jump as much as it did - but that jumped more or less in line with most peoples’ expectations. What was a little bit surprising was to see what happened with the food component - which while still in deflation territory, is significantly less in deflation territory than it was in June.

LINDSAY WILLIAMS: I don’t know if that’s so surprising. Let’s just go back to the producer price index (PPI) for July 2005 - it rose 3.6% year on year, up from a 2.3% year on year increase in June according to Stats SA. But if you just look at the maize price, the fact is that it was R480 a ton about two or three months ago - it’s now above R700 a ton. In percentage terms that’s huge, and it’s a big staple!

GEORGE GLYNOS: It is. What’s been a little confusing - it may be due to the fact that most of the producers that buy these goods do so in the futures market so there tends to be a bit of a lag, but there has been a very big lag in this case between the agricultural futures prices and what we’ve seen coming through in the food and agriculture category in the PPI numbers - so we were expecting it to eventually filter through, but not quite as dramatically as it did in this month.

LINDSAY WILLIAMS: Let’s have a look now at the three sets of data we’ve had out this week, and the prospects for the future given what’s happened with the bond market. GDP was 4.8% up quarter on quarter - great news there, particularly the agricultural economy and the manufacturing economy bouncing back very sharply. CPIX went from 3.5% to 4.2% - still below the mid-point of the SA Reserve Bank’s 3% to 6% inflation targeting range. PPI going from 2.3% to 3.6% - a big jump, and from what the SA Reserve Bank Governor said in his speech yesterday - no more interest rates coming, and inflation is going up. Is that the general consensus?

GEORGE GLYNOS: I think that’s the general consensus. It’s a view that we’re holding - we were hopeful that we may see another rate cut potentially early in the new year if oil prices behaved, and the rand remained resilient - however as we’ve seen oil prices haven’t behaved, and in fact are testing record levels. So looking at the three data sets together - it would suggest that inflation is on a firm upward trend, and is likely to peak in quarter one of 2006. And with growth as strong as it is, and consumers borrowing at the levels that they’re borrowing at - as we will see next week in the money supply and private sector credit extension figures - I would say that the most prudent course of action right now is to keep rates on hold.

LINDSAY WILLIAMS: He does give us hints as well - he doesn’t come on this show, he doesn’t do a lot of interviews, and not many reserve bank governors do - but I must say that if you read between the lines and you are quite clever, and you read every speech and take out the juicy bits - that fact is he is telling us! He told us, when he didn’t cut rates at the last meeting, that inflation was going to be jumping at the next CPIX number - and we’ve seen that this week. The fact is he is saying: "That’s the end of the party!" I don’t know if you agree with that?

GEORGE GLYNOS: I’ve heard that once before - shortly after that we had a rate cut - nevertheless I do believe that we are nearing the short-term bottom of this cycle. I don’t even know if I would call it a bottom - I think we will probably remain stable for a while, and again I reiterate my point that a lot rests with what happens with the rand price of oil. If that subsides towards the end of the year - possibly as a result of a slow down in global growth - then I think that we may still enjoy a further rate cut later on, or next year. I still believe we’re in a deflationary type of environment, however a lot rests with oil.