SA moved a step closer to an upgrade of its international credit rating yesterday after rating agency Moody's gave SA's improved foreign exchange reserves and better growth prospects the thumbs up.

This came as the Reserve Bank's monetary policy committee decided to leave short-term interest rates unchanged, but indicated the outlook for inflation was favourable for at least the next two years.

However, economists said the Bank's decision yesterday to keep the repo rate flat at 7,5%, which was widely expected, did not rule out further rate cuts if oil prices declined or the rand continued to strengthen.

Moody's said it had placed SA's Baa2 sovereign rating on review for a possible upgrade. This commits the agency to a decision within three months, with the probability that it will upgrade to Baa1, a rating that is two notches above investment grade. The other two leading international agencies, Standard & Poor's and Fitch, have SA at one notch above investment grade, but Moody's has traditionally led the pack .

A sovereign ratings notch-up would make it cheaper for SA to borrow on international markets and that should ultimately help to cut the cost of capital in the domestic market.

National treasury director- general Lesetja Kganyago said the spreads on SA's international bonds were likely to start pricing in the likelihood of a ratings upgrade by Moody's, whose analysts are due to visit SA within the next couple of months before making their decision.

The low level of SA's foreign exchange reserves had previously been a key factor holding back an upgrade. But Moody's vice-president Kristin Lindow said yesterday that SA's international liquidity position was now fully consistent with a rating at this level.

SA's external assets were now such that SA could avoid a lot of the volatility, in the exchange rate and in capital markets, that had plagued it in the past, she said.

Moody's was also more optimistic about SA's ability to sustain a stable healthy growth rate. "It seems as though things have really stabilised and improved and we are looking at a situation where SA will achieve quite good growth for several years to come."

Two issues that the agency would be checking out on its visit to SA were whether there was any chance of a reversal of the strong capital inflows SA had been seeing, and whether the big pick-up in domestic credit demand indicated any "overheating".

Bank governor Tito Mboweni said yesterday the inflation outlook was "promising" over the longer term. But he highlighted the unpredictable rand, soaring oil prices, high wage costs and strong domestic demand as factors causing the Bank to hold rates steady yesterday.

The rand strengthened to below R6,50 to the dollar following the Moody's announcement, almost 10c stronger than its previous close of R6,5975. The local unit fell back late yesterday to trade at about R6,5135.