Wikus Furstenberg: Pravin must show business he’ll walk his talk

Head of interest rate process at Futuregrowth, Wikus Furstenberg, has been crunching the numbers Finance Minister Pravin Gordhan has to work with ahead of Wednesday’s Budget. In this interview with Biznews.com’s Alec Hogg, he explains what the reappointed Finance Minister will need to table to show the re-engaged business community he can deliver on what is being promised. Read no increase in corporate tax, concrete evidence of expanding Public Private Partnerships; a more stringent approach to State Owned Enterprises – and, to provide his fiscal conservatism, an increase in VAT.

This special report is brought to you by Futuregrowth and Wikus Furstenberg, who’s Portfolio Manager and Head of the Interest Rate process at Futuregrowth joins us now. At a time when people are battling to understand the Rand volatility and the movements in interest rates Wikus, we’ve got the Budget coming up this week. How important is that going to be in the way that interest rates go forward and indeed, the exchange rate?

Alec, it’s crucial. What the market as a whole is hoping for is commitment from Government to fiscal consolidation. There’s nothing new in that and we’ve heard many promises in the past. It’s not just in the last week. Really, now is the time for them to deliver on that as well. I think there are probably two things that the market will be looking for: (1) exponential seeding. Please don’t exceed it. In fact, if any, we’d like you to cut expenditure. (2) The end result that we would like to see is some debt stability – a proportion of total Government debt – of GDP and that needs to come down. If you include those contingencies, the explicit Government guarantees to state-owned enterprises, etcetera…we’re already sitting at just south of 60 percent. It’s simply too high. We can’t afford that.

So there are quite a few signals that we need to watch out for.

Definitely. What worries me a little bit is that a lot of noise has been made since the fiasco in December – the ‘do not worry. We will deliver and we will make good’ – and I think there’s some expectation in the market already that this is going to be a good Budget from a market perspective. Again, with the emphasis on consolidation. Obviously, what makes it very difficult for the Ministers is to find that balance between consolidation and the issues around growth, and profound weakness of growth is obviously a major problem that cannot be fixed quickly. You referred to the currency earlier on. I think that some of the issues around the currency relates to not just global growth, but also local growth and it’s going to be a difficult one this time around.

We’ve seen the currency pick up in the last few days, though. Is there anything that we can read into that?

I think you mentioned the difficult around getting the currency right. I think the first thing is that we have to acknowledge that globally, the Dollar has lost some ground. One of the reasons the Rand was so weak amongst other emerging market currencies is Dollar strength globally, right? It’s simply because the Fed is the first major central bank that’s in position to actually start normalising rates and relative stronger growth when the U.S. supports the Dollar – that’s the first thing. What we saw a little last week was some concern about growth momentum in the United States. The Dollar’s lost a bit of ground and obviously, that will help the currency but then in the second phase there’s this expectation that we refer to locally, which is ‘all eyes are on what Government is going to deliver in terms of this promise of fiscal consolidation and how exactly they’re going to get to that’.

The thing that worries me a bit is that there’s already some expectation going back into the market. Having said that, it’s always important to keep perspective. We need to go back to see where the Rand and local bonds were trading before we had that fiasco in December. We still have some way to go to recover some lost grounds so maybe we should just keep that in mind as well.

Yes. Bonds were around 830. They’re still at nine – almost 100 basis points higher than what you referred to as ‘the fiasco’. How long will it take to get that out of the system – get Nenegate (as we call it) behind us?

I like to look at it in two ways. (1) You have the monetary authorities on the one hand and of course, the fiscus on the other. In terms of the South African Reserve Bank, we’re very happy with what they’ve been doing and the reason why they’ve been doing what they did. The increase in the repo rate recently was done for the right reasons. We need to manage inflation expectations – they only tool that they have – and the hard way to do that is to use interest rates. We’re fairly comfortable with that pillar in terms of policy credibility. On the fiscal side, we already made some sound announcements. The first thing was the appointment of Mr Gordhan for the second time. That was a quick recovery. There’s a silver lining in that. The second thing was that immediately after that was the commitment to do what is right. It’s nice to hear that.

At least, there’s some acknowledgement. We’ve all heard that now. What’s been happening with the SAA thing also helped in late December, where [inaudible 0:05:46.4] said, “We’re not going back. We’re sticking to that initial agreement with Airbus.” That was a good one. Next week is important so see a lower Budget Deficit. That’s what we’re hoping for – a three percent Budget Deficit as a percentage of GDP for 16/17 as opposed to something closer to four. That’s going to require them to cut expenditure but also, to raise taxes I’m afraid to say. Then Alec, to really recover…the proof is still in the pudding. We’ve been here before so it’s going to take a few months for that credibility to recover on a more sustainable basis. You’re going to see short-term reactions from the market – relief rallies and all that – but at the end of the day (and that’s going to take months)…

October is probably the next target and then February next year because we cannot – again – stiff on the commitment to consolidation. We cannot do that. That commitment needs to be backed by realistic assumptions as well. We cannot again, say growth is going to grow for instance, – this and next year – at two and three percent. It’s not going to be that high. They have to acknowledge that and that is very important because if any of these are based on unrealistic assumptions in terms of the macro backdrop then that credibility will not recover.

So acknowledge reality, as bad as it might be.

Yes. It’s not about October, February, or December last year. It’s about what happened the last three years. There’s been persistent slippage and it’s crept into the number, and we need to consolidate. We cannot continue like this anymore. That’s the one thing. The thing that worries me more – obviously, we heard the ratings agencies. In my mind, they’re still backward-looking – but nonetheless there’s this concern about growth. You cannot expect the Minister to fix our growth problems in one Budget speech. It’s not going to happen. It’s a process and it’s going to take a long time. It’s a difficult thing to do and it’s something that has been neglected for a number of years now. I’m not convinced that a good budget will necessarily prevent an investment downgrade in few months’ time.

Wikus, what can be done? To your point there, the ratings agencies are now looking for higher growth and fiscal discipline. Pravin Gordhan can give them the fiscal discipline – one presumes -, given that the President is now supporting him but as you say, he cannot switch on the growth engine or the growth tap. As a consequence, you almost have to ask yourself, “Well, we’re going to junk status. Why bother?”

I think it’s all about debt stability and the sustainability of the debt holding that we have. Just to put that into perspective, if you compare us to a sample size of about 42 countries, we don’t look that bad at all. That’s not the point, though. The point is that it’s getting more expensive to service the debt and it’s going to become increasingly difficult to do that if we don’t consolidate that now. We should not just be focused on what ratings agencies may or may not do. Keep in mind that we only received an investment grade for the first time somewhere in February 2000, from S&P. We were running sub-investment ratings before. My issue is that we need to do the right thing for the right reasons. We’re all jumping up and down (including Government) about this risk from ratings agencies but the focus really should be what we should be doing locally to get things right.

The first thing that we need to do is to manage the costs of servicing that debt of ours because at the end of the day, what happens there is you take away from somewhere else to service this debt and that’s something we cannot afford. We can ill-afford that. That’s what Trevor Manuel and his team managed to do very well in the good old, early 2000’s when we were in a similar position in terms of these things and they gradually ground the deficit to lower levels and in the process, funded less. Eventually, they got into the position where they actually bought back debt and they did that because they wanted to free up some cash for social and infrastructure spending. That’s what we need.

That’s a sensible way of doing things and as you say, we’ve had slippage over the past three years, which means we’re back in that mode or that way of thinking. You did mention that you expect there to be tax hikes in the Budget and some cuts in Government spending. Could you be a little more specific? Where do you see the tax hikes coming and indeed, where do you see scope to cut back on state expenditure?

I’m going to start with the difficult one because we simply don’t have all the information, do we? On the expenditure side, it sounds harsh and it’s probably unrealistic but you need to do something about that wage bill. It’s just taking up too much. It’s going to be very difficult to do and they’re probably going to cut back on some infrastructure spending for now as well. You cannot cut back on social grants. Anyone who promotes that is foolish because it’s something we cannot afford to do at this point in time, and so you need to look elsewhere. All I know is that we’ve done the numbers and to get to a budget deficit of around three percent, which I think the market would be [sort of] happy with for now, they need to cut expenditure by X and they need to look at that wage bill of theirs. That’s on the expenditure side. On the revenue side, it’s probably a little easier.

There are a number of things, which they could do. Given the Gini coefficient that we’re battling with in South Africa, the big spread between high and low income earners… Personal income taxes for the upper income earners I’m afraid to say, is relatively easy to get away with that. Obviously, you need to be sensitive to how much you do. I don’t think you should do more than one percent but something needs to be done in terms of that. The Capital Gains Tax thing, Dividend Tax, Estate Duties, and Syntaxes. The Fuel Levy. Remember what happened last year? The petrol price was lower. It gives them some sort of leeway there to do something. There are quite a few analysts out there who are also thinking that maybe we should just do something about that. That was obviously a consideration. Whether they’re going to have the stomach to do that is obviously a different story.

We’ve looked at numbers and what we would like to see… We don’t have to do that rate hike now. We would be able to get away with higher tax by addressing those factors I mentioned. From a bump market perspective, that hike will be very bond-friendly simply because it’s easier to do and you can guarantee on that tax revenue coming through.

If you have your back against the wall from the ratings agencies’ perspective and you want to try and keep your costs of borrowing down, the way to do it is to increase VAT. That’s the easiest way of doing it. Alternatively, you can fiddle with a number of things. As you say, Capital Gains, Top Income, and the Fuel Levy, (which already went up 80 cents last year). You wonder how much scope there still is to take that one up, but I’m sure they’ll find it – Dividend Tax, Estate Duty etcetera. The easy way economically, would be VAT but that’s very difficult politically.

I think it’s very difficult politically, unless you use programs like National Health Insurance as an excuse to do that. That would be ‘first prize’ if we could do something about the VAT. We will probably find a combo between the ones I’ve mentioned and then maybe a smaller VAT hike. I don’t know whether it’s too late for them to look at that now. Maybe it’s something for next year.

Read also: Matthew Lester: Budget Bets – VAT a last resort.

With Pravin Gordhan apparently in a very strong position, if ever a VAT hike was going to be palatable, now might be the time.

Well, you can certainly make a case for that, Alec. He is in a strong position. You can only imagine what had happened in December before his appointment was announced. It certainly would help. I think it will add to anti-policy credibility as well. You’re prepared to do that in a year where you’re [inaudible 0:16:00.0] municipal elections where you as the ANC, don’t feel too comfortable about the potential outcome in certain districts. It certainly would assist in terms of that policy credibility because that is one of the strengths, which we have. If we compare us with Brazil for instance, Brazil is just nowhere in terms of policy credibility – absolutely nowhere and that was one of our relative strengths. If we can regain that, it will certainly help a lot.

The big story when looking at the Budget is policy credibility. The way that one could enhance that would be by increasing the VAT rate. Whether that’s politically palatable, we will only know then. Is there any upside though, in all of this? South Africans are desperately trying to find hope somewhere. Can you give us some guidance?

Let’s be realistic. That commitment to fiscal consolidation coming from the Minister next week: in my mind, that’s good news because we’re going back to what we said before. Obviously, what Government needs to do (and they’ve talked a lot about this)… I don’t know whether we’re going to add any value by repeating this – the so-called new openness to a public/private partnership. For instance, in particular for infrastructure development. A new, more stringent approach to SOE’s is very important. We know what’s happening in some of those bigger SOE’s. They need to follow through on that promise and then of course, the privatisation thing. I don’t want to make too much of the privatisation thing because for now, I don’t think that’s realistic. You also cannot ignore the labour units. That will be silly. You can’t do that.

There’s always those risks where you make all of these promises, but they end up being unrealistic and you’re unable to deliver. The word ‘deliver’ brings me to the next point. Now is the time to deliver and I think they need to communicate to us as well in terms of progress that delivery of all these subjectives. It’s very important. We can’t wait for the table. We want to see consistent communication in terms of that.

From a business perspective, once Pravin Gordhan has spoken on the 24th; if you were to take the most realistic changes that would delight business rather than perhaps those which they would pray for – just the realistic ones -, what would be the messages? What would be the signals we should look for?

The first thing is that we don’t see an increase in corporate tax rates. There’s an acknowledgement time are difficult so we’re not going to do that and that’s why I haven’t listed that as a potential source of more tax revenue. Again, we may go back to that follow-through on recent meetings with CEO’s opening the gates to discuss these things, and go out and see what we can get from business in terms of helping us to solve our problems. Let’s work together. We need to get labour into that negotiation as well. I forgot to mention this whole nuclear energy thing as well. I know what the Minister said. He said, “Don’t worry. We will look at what we can afford.” We also need to remember that again. Is what we’re going to be doing, the right thing? We cannot afford that at this point. Going forward, we will do a proper analysis of what can be afforded.

Wikus Furstenberg is Portfolio Manager and Head of Interest Rate processes at Futuregrowth and this special report was brought to you by Futuregrowth.

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