SA is set for a lucky reprieve in the form of another revenue overrun of more than R100bn for the third year in a row. As before, this welcome surprise has been mainly driven by the commodity boom, extended by the war in Ukraine, which has resulted in windfall corporate income taxes.
At the same time, much higher inflation than initially expected by the National Treasury’s conservative budget office has boosted nominal GDP growth — the anchor of all fiscal ratios.
The upshot is that economists expect the main budget deficit for 2022/2023 to be revised down in the medium-term budget on October 26 to below the Treasury’s February budget target of 6% of GDP, possibly to as low as 4.5%. This would keep the debt ratio down at about 70% of GDP.
All of this is welcome news — for business and investor confidence, for SA’s credit ratings, and for the consumer, who will likely be spared further tax increases (other than the usual inflation adjustments) and may even get some tax relief in next year’s national budget.
“This is likely to be a feel-good budget,” says Sanlam Investments’ economist Arthur Kamp. “Even including Eskom’s debt, the National Treasury can show a favourable path for the government’s debt ratio over the medium term relative to its previous projections.”
This is likely to be a feel-good budget
— Arthur Kamp
There is an expectation that the long-awaited plan to deal with Eskom’s R400bn debt will be unveiled in the medium-term budget.
Finance minister Enoch Godongwana is expected to announce a debt swap, with the state taking at least R200bn of Eskom’s guaranteed debt onto its own balance sheet. This would add about 3.5% of GDP to the central government’s debt, causing the debt ratio to increase from 70% to about 73.5%.
Citi economist Gina Schoeman says this need not be “startling”, provided Eskom can inspire confidence that once it accesses cheaper funding it will improve its operations so as not to keep running up more debt.
BNP Paribas senior economist Jeffrey Schultz doesn’t expect a R200bn Eskom debt swap to be credit negative for SA, as the main credit ratings agencies already regard Eskom’s debt as effectively government debt. In fact, he says it could be seen as a positive step because the state will be able to scrap the R23bn in bailouts it was paying each year towards Eskom’s debt service costs. In addition, the state can service Eskom’s debt 350-400 basis points cheaper than the utility because it has a higher credit rating, saving several billion rands a year.
SA is heading for another R100bn revenue overrun, but huge spending pressures are building down the line
— What it means:
SA’s medium-term outlook, however, is less sanguine.
Over the past few years, a positive terms-of-trade shock and historically loose global economic policy have supported SA’s fiscal position. The situation is very different now: global monetary conditions have tightened considerably and will likely cause a global recession and, with it, the dissipation of the commodity boom.
SA’s commodity export prices have been falling, net financial inflows remain weak, and the current account has slipped back into a deficit.
In addition, persistent expenditure pressures continue to bubble up from SA’s disaffected populace — pressures that cannot easily be met by a country with such a low potential growth rate. The looming ANC elective conference and the 2024 general election will make it hard for the governing party to resist demands for greater social spending.
Given these factors, both Kamp and Schoeman foresee that SA’s deficit ratio will widen anew next year, pushing the debt ratio higher. Schoeman expects it to hit 79% by 2024/2025, but much depends on the policy decisions that are taken before then.
For instance, Godongwana will have to find at least R45bn a year if the government decides to extend the social relief of distress (SRD) grant — much more, if the benefit is raised from a paltry R350 a month to the food poverty line of R663 a person.
Moreover, the public sector wage settlement will likely exceed the R20bn buffer the Treasury built into the 2022/2023 budget to cover the possible extension of the R1,000 a month nonpensionable gratuity.
It seems likely that public sector workers will receive a 3% nominal increase, plus the usual 1.5% pay progression, as well as the R1,000 monthly gratuity. This would be equivalent to a 5.6% average increase, which would exceed the budgeted amount and the buffer by about R20bn.
In addition, SAA, Denel and the SA Post Office are demanding fresh bailouts totalling R5bn, even though the 2022 budget made no provision for any further financial assistance for state-owned enterprises.
Business Leadership SA CEO Busisiwe Mavuso warns that “considerable pressure” is also going to emanate from the R443bn in government bond redemptions that will fall due between 2023 and 2026. This compares with only R159bn in redemptions over the past four years.
“We’re in a real bind here,” she says, as SA will have to borrow new money from the markets at rapidly rising interest rates if it is to meet these payments.
She also estimates that rising debt service costs are going to add R9bn to government expenditure this year. Meanwhile, she fears that pressures for increased spending in other areas will intensify in the context of a weak economy.
“The burden of the higher bond redemptions ... has to be repaid before any requests for extra expenditure are even considered,” she says.
Kamp’s view is that SA’s expenditure profile shouldn’t be lifted any further at all given the weak global and domestic growth outlook.
But Colin Coleman, the former MD of Goldman Sachs in Sub-Saharan Africa, disagrees.
“The budget is about more than just making the numbers look good for the ratings agencies,” he says. “It’s about how we’re breaking out of our structural constraints and problems.”
He adds: “Yes, the benefit of fiscal consolidation is to reduce the cost of capital to increase investment, but that’s an insufficient condition for investment.”
Coleman argues that the budget also needs to address the “festering sore” that is unemployment, lawlessness, corruption, public mismanagement, and SA’s eroding network industries and structural low-growth problem.
If he were in charge, Coleman would expand the SRD grant to R600 a month for all 12-million beneficiaries and give R5,000 grants to each of the country’s 2.5-million micro enterprises, “because the stimulatory impact on the economy and the people would be huge”.
He says SA can afford this fiscal stimulus, basing this on Goldman Sachs’s bullish opinion that commodity prices will remain elevated, at least in rand terms, over the medium term.
The budget is about more than just making the numbers look good for the ratings agencies. It’s about how we’re breaking out of our structural constraints and problems
— Colin Coleman
This view is not shared by the Treasury, which has stressed repeatedly that SA cannot afford to extend the SRD grant based on cyclical commodity windfalls, only on a structural increase in taxation.
Given the recent downturn in commodity prices, the Treasury is likely to provide conservative medium-term growth and revenue forecasts on the day.
This game plan has allowed it to claw back some credibility following a long period of consistently missed targets after the global financial crisis. During that period, government expenditure was allowed to remain too high in relation to the revenue that the dwindling economy was able to generate. This led to stubbornly large fiscal deficits and a rapidly rising debt mountain.
In the fiscal consolidation period that followed, SA’s budgets have continued to assume that extreme expenditure restraint will prevail and that structural reforms will improve the country’s growth rate, allowing debt to stabilise.
The most recent target has been for debt to stabilise at 75% of GDP by 2024/2025. (In the October 2013 mini-budget, the target was 44% by 2016/2017.) However, many observers are highly sceptical about whether SA will be able to sustain the sizeable primary budget surplus (revenue minus noninterest expenditure) required to reach this.
Though Schultz expects the Treasury to achieve its goal of posting a primary surplus in 2023/2024, it is likely to be too small, and short-lived. Schultz expects the debt ratio to keep rising by 1.5-2 percentage points a year, even if SA keeps running a primary surplus, because the real cost of financing is likely to exceed real GDP growth by this factor.
The problem is that the Treasury’s narrative is that fiscal consolidation is just a temporary burden and that as soon as the country achieves a primary surplus, things can go back to normal. But in the absence of decent economic growth, stabilising the debt ratio will depend on persistent expenditure restraint, which is going to be exceedingly difficult to deliver.
Given all the urgent needs facing the country, BLSA is “extremely concerned” that SA may stray from its tight fiscal path.
The worry is that while the Treasury’s budgets may look good on paper, the rest of the government may prove unable to adhere to the Treasury’s expenditure plans or expedite the reforms necessary to boost growth.
So, the markets are likely to rally on October 26 over SA’s improved fiscal metrics. But unless the country deals with its structural problems so that it can generate sustainably faster growth and stronger revenues, the cheering will be short-lived.
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