Investors reassured but medium term risks loom for SA economy – Thea Fourie, S&P Global Market Intelligence

Finance Minister Enoch Godogwana has described South Africa’s public finances as significantly weaker in his mid-term budget emphasising that measures to stabilise public finances and reform the economy to generate higher growth are essential. Markets reactions were generally favourable with the rand strengthening. Thea Fourie from S&P Global Market Intelligence said in an interview with Biznews that lower expenditure was a welcome surprise and that the investor community appeared to be happy with Mr Godongwana’s projections, but said concerns lingered about the persistent rise in the public sector debt-to-GDP ratio. Medium term risks remained on the horizon, she said. Transnet and Eskom, Fourie warned could be bad news for the debt trajectory. These risks she said raised concerns about the government’s ability to achieve its objectives. – Linda van Tilburg

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Excerpts from the interview

Lower expenditure a welcome surprise

I believe there were several surprises in today’s budget. The consensus was that there would be some degree of revenue underperformance, estimated at around 50 to 60 billion rand, and indeed, this turned out to be the case. To be precise, there was an underperformance of 56.8 billion rand on the revenue side.

However, the real surprise came on the expenditure side. Expenditure is set to be lower than what the markets had anticipated. As a result, the overall budget deficit stands at 4.9% of GDP, which is unexpected. In the previous February budget, the deficit was projected to be around 3.9% of GDP. Many analysts were looking at a budget deficit of 6 to 7% of GDP. So, this unexpected restriction in spending until February next year is indeed a welcome surprise, one that we’re very encouraged about. 

Investor community overall happy with the budget

Prior to the budget release, the South African Rand demonstrated a significant appreciation against the US dollar. Post-budget, it managed to sustain its value. Bond yields exhibited minimal movement as well. On the whole, the investor community appears content with the budget. Nevertheless, concerns linger about the persistent rise in the public sector debt-to-GDP ratio. The postponement of the timeline to reach the peak in public sector debt levels, now projected for 2025 or 2026, somewhat offsets the positive sentiment stemming from the relatively modest increase in the budget deficit as a percentage of GDP.

The budget reflects that it is an election year

I believe that the public sector wage bill and the social relief grant underscore this point. Additionally, the finance minister’s announcement that there will be tax increases next year lacked clarity about the specifics. We still need to discern where the additional 15 billion grant will originate. He seemed cautious about divulging too many details. Trimming expenditure in a pre-election year is indeed a bold move, but it’s crucial to scrutinise which spending components are being reduced; that’s the key consideration.

Regarding the restructuring and downsizing of the state, this isn’t feasible in the short term, especially in the lead-up to the elections. This issue extends beyond South Africa and is challenging to implement in the broader context of sub-Saharan Africa. Therefore, it’s unlikely to occur within the next 12 months.

As for the preservation of the grant, it didn’t surprise us. In the medium-term projections, there is an allocation of funds that allows for the continuation of the social relief grant. Consequently, the longer it remains in place, the more difficult it becomes to discontinue.

Transnet could be bad news for debt trajectory  

The increasing fiscal debt is indeed a problem, especially as the target for reaching the peak keeps getting pushed further into the future. It appears that the South African government is encountering significant challenges in achieving its debt reduction goals. Another concerning issue is the situation with Transnet. They have been vocal about seeking government support, including injections and debt relief, similar to what Eskom  received. These factors combine to create a very concerning and problematic picture. Additionally, given recent disclosures about Eskom’s overspending in launching the emergency electricity program, the reality of missing public debt targets becomes more evident. This concern is amplified in the context of a low-growth environment.

The finance minister was quite explicit that specific conditions must be satisfied. If an agreement can be reached regarding these conditions, there might be potential for unlocking support. It’s worth noting that the assistance provided to ESCOM is also tied to certain conditions. So, if this is a feasible option for the finance minister, it could potentially lead to some support. However, it remains a complex matter. While it has the potential to significantly impede economic growth, it could also have detrimental effects on our debt trajectory.

Is the finance minister’s targets achievable? 

Balancing government spending components is crucial for ensuring long-term growth potential. Continuously allocating resources to recurrent expenses like public sector wages and social grants without enhancing production capacity through infrastructure development is unsustainable. To foster economic growth, it’s essential to invest and generate savings.

As for the cuts in state expenditure, the focus should be on the public sector wage bill. Additionally, reducing the reliance on state-owned enterprises (SOEs) for fiscal support is necessary. A thorough examination of how to address SOEs is vital, including considerations like rationalisation, closure, and privatisation. While implementing job cuts or rationalising state-owned entities like SAA can be challenging, these areas should be the primary focus when assessing government finances.

Medium term risks on the horizon

When reviewing the initial budget release today, it doesn’t appear overly negative. As expected, there was revenue underperformance, and the deficit isn’t as high as a percentage of GDP as many had anticipated. However, the major concern lies in the continuous increase of the public sector debt to GDP ratio, with the peak of this ratio being repeatedly pushed out. It’s evident that the government is facing challenges in reaching its debt targets.

In the medium term, there are certainly risks on the horizon that could further elevate the public sector debt to a significantly higher level. Consider the demands and requirements from Transnet on the financial side, which, if added to the budget, would push the public debt to GDP ratio even higher. Additionally, failing to adhere to wage agreements over the medium term would have the same effect, resulting in a much higher ratio to GDP. These issues raise concerns about the government’s ability to achieve its objectives, as it appears to be struggling in this regard.

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