Moody's Investors Service has assigned a provisional (P)Baa1 senior unsecured rating to the envisaged issuance of Sukuk certificates by ZAR Sovereign Capital Fund Propriety Limited, a special purpose vehicle established in South Africa by the South African government. The payment obligations associated with these certificates are ultimate obligations of the Republic of South Africa.
"The Republic of South Africa's envisaged inaugural Sukuk offering reflects the growing interest in Islamic finance as a source of sovereign funding," said Khalid Howladar, Global Head of Islamic Finance at Moody's Investors Service. "This landmark issuance may pave the way for other South African borrowers to tap Islamic capital markets," he added.
"Moody's Baa1 government bond rating on South Africa reflects, amongst other factors the economy's diversified productive base, with substantial value-added from domestic sources," notes Kristin Lindow, lead sovereign analyst for South Africa. "Still, the poor investment climate, not least in the key mining sector, and structural external deficits factor into the negative outlook," she said.
The (P)Baa1 rating assigned to the trust certificates is at the same level as the long-term local-currency and foreign-currency issuer ratings of South Africa, as the Sukuk certificate holders will (i) effectively be exposed to South Africa's senior credit risk; (ii) not be exposed to the risk of performance of the Portfolio Assets relating to the Certificates; (iii) will not have any preferential claim or recourse over the Trust Assets, or rights to cause any sale or disposition of the Trust Assets except as expressly provided under the Purchase Undertaking; and (iv) only have rights against the Republic of South Africa and the SPV, ranking pari passu with other senior unsecured obligations as provided in the transaction documents.
Moody's also notes that its Sukuk rating does not express an opinion on the structure's compliance with Shari'ah law.
The proceeds of the Sukuk certificates will be used by the ZAR Sovereign Capital Fund Propriety Limited to purchase interest in a portfolio of properties owned by the Republic of South Africa. Subsequent to the purchase, the Issuer will enter into a lease agreement with the Republic of South Africa ("the Lessee"). Pursuant to the terms of the agreement, the Lessee will periodically pay an amount sufficient to fund distributions payable by the Issuer under Sukuk. Upon the dissolution of the transaction, the Republic of South Africa will purchase the lease assets at the exercise price, thus providing the principal amount payable by the Issuer to certificate holders. If the dissolution is triggered by a total loss event and the insurance proceeds are not sufficient to cover the amount payable by the Issuer, the Republic of South Africa will pay an amount equal to the shortfall.
Moody's says South Africa's infrastructure is highly advanced compared with other emerging markets and its institutions, most notably its judiciary, are stronger than those of its peers. Moreover, South Africa offers by far the deepest capital market and the most sophisticated financial system in Africa. While its government debt metrics have deteriorated significantly in the past five years, its debt and debt service remain manageable. In part, this reflects the low share of foreign-currency denominated debt, which provides stability in the context of a volatile exchange rate. Moreover, Moody's expects the government's direct debt to stabilize as a ratio to GDP within the next two years because of spending restraint and revenue buoyancy, despite a slow-growing economy.
Still, the legacy of apartheid means the country continues to face the triple afflictions of high unemployment, poverty and income inequality. The economy has never fully recovered after the 2008-09 global economic crisis, resulting in sluggish employment opportunities, a shortage of private investment and rising government debt, which is now more than 20 percentage point higher than two years ago. Industrial relations also have been divisive, another deterrent to investment as well as exports. These developments inform the negative outlook we currently have on the government's rating.
WHAT COULD CHANGE THE RATING UP/DOWN
Moody's has aligned the senior unsecured rating of the Sukuk with South Africa's Baa1 issuer rating. The rating on the Sukuk is expected to move in tandem with South Africa's issuer rating. Higher domestic savings and investment rates would support South Africa's rating, and, in turn, the Sukuk rating, as would sustainably stronger growth, restrained public debt accumulation and the maintenance of sound economic policies by the current administration and its successors. Conversely, the ratings could be downgraded should the government's direct debt continue to deteriorate in a manner inconsistent with future debt sustainability.