Economists are falling over themselves to revise SA’s near-term fiscal outlook upwards as the commodity boom translates into a far stronger domestic economic recovery than many expected. The prospect of an imminent fiscal crisis is now firmly receding and, with it, the danger of further ratings downgrades.
Along with the commodity windfall — which has brought about R100bn of additional income into the economy — higher inflation, a firmer rand, a reduction in sovereign credit risk and the recent spurt of reform (on energy, SAA and the ports) are all contributing to SA’s fiscal turnaround.
"Suddenly everything is coming together," says Deutsche Bank senior economist Danelee Masia, who expects real GDP growth to average 4.8% this year, against the National Treasury’s 3.3% estimate.
Masia has stuck her neck out to predict that SA’s debt-to-GDP ratio could fall in 2021/2022. It would be the first annual decline in 14 years. In fact, she now expects national debt to peak at 78.4% in five years’ time — a full 10 percentage points lower than the Treasury’s estimate of 88.9%.
Consequently, she believes the next move on SA’s credit rating will be upwards.
If she is right and nominal GDP growth comes in much better than expected, then, far from SA’s public finances being dangerously overstretched and the country being in line for a sovereign default, the Treasury could easily achieve its planned fiscal consolidation over the next three years.
The big shift since the February budget that has transformed SA’s fiscal prospects was the economy’s 4.6% outperformance in the first quarter, at a time when many economists had feared that growth would turn negative due to the Covid second wave.
This has lifted SA’s GDP base over the remainder of the year and is the main reason why the fiscal numbers look so much better, explains Masia.
The whole-year growth consensus for 2021 has shifted up dramatically in response, from the 3.7% forecast in May, before the GDP data was released, to 4.6% in June.
SA’s recovery is largely thanks to the surge in its terms of trade, which has risen by almost 12% over the past year and more than 20% since the end of 2018 — one of the strongest gains on record. Masia estimates that this commodity cycle uplift has brought about R100bn of additional income into the economy. This will fuel a large revenue overshoot for the second year in a row.
"We can’t say yet whether this will translate into real economic gains, but we can say that higher GDP growth already means total revenue collection will overshoot by R60bn-80bn," she says. "If it also leads to higher investment and job creation, then our estimates for the revenue overshoot will be conservative."
Last week, Sanlam Investments chief economist Arthur Kamp made similar revisions, upgrading his 2021 real GDP estimate to 4.5% and pencilling in a R70bn revenue overrun for the current fiscal year. This should allow the debt ratio to fall to 78% by March 2022, as opposed to the Treasury’s expectation that it will keep climbing north of 80%.
Deutsche Bank is even more bullish, forecasting that the debt ratio could fall as low as 76% in the current fiscal year, even if the government gives a little on the wage front.
But SA’s improved fiscal prospects are not just because of the commodity boom. The firmer rand, somewhat higher inflation, a reduction in SA’s credit risk, the Treasury’s spending restraint and the recent movement on energy and other structural reforms — which Masia describes as "a political turning point" — are all contributing.
For instance, more than R100bn could be wiped off SA’s debt profile (including Eskom) over the course of the year due to revaluation effects stemming from the stronger rand.
"There are massive ramifications when the rand works in your favour, because a stronger rand reduces your dollar liabilities," says Masia.
Where rand depreciation in previous years would typically add 1.5%-2% to SA’s debt profile, she estimates that it will drop by about 1.7% of GDP (about R85bn) in 2021/2022 purely due to revaluation effects.
And Eskom recently announced that its debt was reduced by about R80bn during the 2021 financial year, partly due to debt repayment and partly due to revaluation effects. The foreign exchange benefit could be sustained in the current year, should the rand remain strong.
The improvement in SA’s fiscal prospects has significant implications for the conduct of fiscal policy, as well as SA’s credit ratings, for not only is SA’s potential new debt trajectory considerably better than the Treasury’s February estimates, it is hugely better than the forecasts of all the main credit ratings agencies.
University of the Free State economics professor Philippe Burger fears that higher economic growth will increase pressure on the government to relax its fiscal stance. But he urges it not to repeat the mistakes it made after the 2008 global financial crisis, when it misinterpreted a temporary commodity swing uplift as evidence that SA had bounced back from the crisis, and ramped up spending on permanent entitlements such as wages and social grants.
"The commodity boom will allow us some space to undertake fiscal and economic policy restructuring," he says. "We need to ensure that we use the time well so that by the time the boom is over we don’t face the same underlying structural fiscal and economic misalignments we saw in the past few years."
Though Masia believes SA has avoided a potential fiscal crisis, she also cautions that we are not yet out of the woods, nor can the Treasury give much more rope on public sector unions’ wage demands.
"If it does, it will unwind the gains from the commodity cycle and improved growth within … one to two years," she says. "We still have a very high debt ratio by peer standards and large future deficits to fund against a very uncertain global funding backdrop."
SA also still has no idea as to the permanent scarring effects from Covid on the labour market or on corporate tax collection. Though there has been movement on structural reform, Masia argues that it will first have to translate into higher private fixed investment to shift the needle on growth.
"Ultimately, SA needs higher growth to secure debt sustainability," she concludes, "and it seems the jury is still out on this."
Kamp makes much the same point, stressing the importance of looking through the short-term cyclical commodity-related windfall and at the longer-term fiscal trend.
"At some point the commodity price cycle is likely to turn down. At that time, we will need more fiscal space," he says. "In any event, we should not be aiming to just stabilise the debt ratio. We need it to decline sustainably."
The last time SA experienced a commodity super-cycle, the debt ratio was on a downward trajectory, interest rates were shifting structurally lower, and the company tax rate was falling. This unleashed the strongest private sector investment upswing in the country’s history.
This time conditions are different, with economists anticipating only a modest pick-up in investment into 2022. This is partly why the consensus is for real GDP growth to fall back closer to 2% from next year and for the debt ratio to continue to drift higher after a short hiatus.
To secure long-term fiscal sustainability, Kamp says SA’s potential growth rate will have to lift to about 3%, with the government maintaining prudent expenditure levels. That’s something that will be difficult, given SA’s vast socioeconomic needs.
We still have a very high debt ratio by peer standards and large future deficits to fund against a very uncertain global funding backdrop
— Danelee Masia
HSBC economist David Faulkner says the current environment creates a window for policy reform that addresses the structural constraints to faster growth and the factors undermining fiscal sustainability.
While welcoming recent reforms, he believes much more is needed, noting that investment spending has collapsed, energy shortages persist and fiscal pressures remain skewed towards more spending.
"These are economic challenges that will require sustained policy action to reverse," he says. "They also leave SA with balance sheet vulnerabilities at risk of being exposed, should the recent rise in metal prices prove transitory or risk appetite sour."
But even if the longer-term challenges remain daunting, the improvement in SA’s near-term fiscal position should be enough to prevent further sovereign rating downgrades for the foreseeable future.
While S&P is expecting SA’s debt to rise to 88.4% over the next five years, Moody’s expects it to exceed 90%. Both agencies are also highly sceptical about the prospects for structural reform; both will now have to recalibrate their views.
"Moody’s has worked disappointment and reform inertia into its numbers," says Masia. "It will definitely be surprised, but it will want to see hard evidence, so will most likely wait until February 2022’s budget numbers before taking the ‘negative’ outlook off SA’s ratings."
She thinks S&P could upgrade SA’s outlook from "stable" to "positive" as early as November purely on the improvement in SA’s fiscal position. However, it is unlikely that SA will experience any full-notch upgrades until energy reforms bear fruit and load-shedding stops — a prospect that is still one to two years away.
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