National Treasury is facing an extremely tight budget with little to no room to manoeuvre, says Nedbank – which may force the country down one of two unpopular paths in the coming years: issue foreign currency bonds, or head to global financiers like the International Monetary Fund (IMF) for help.
Either route is not great for South Africa, the bank said, with the former carrying interest rate and currency mismatch risks, and the latter bringing terms and conditions that will be political poison – particularly with elections coming up.
However, unless government can bring spending under control, these may be the only options left, Nedbank warned.
The background to this view simple: the economic impact of Covid-19 has been, and will continue to be severe. The economy is in decline, revenue collection is slipping, and the budget deficit is ballooning as spending increases.
“National Treasury’s ‘slow’ scenario, under which real GDP plunges by 12.1% in 2020, seems plausible, although our forecast is a lower -8.1%,” Nedbank said.
“Government projects the main budget deficit to more than double to 14.6% in 2020/21 compared with the 6.8% estimated in the February 2020 budget, with wider outcomes also expected in 2021/22 and 2022/23,” it said.
The driving forces behind this growing deficit are:
- Bailouts being paid to failing state enterprises;
- The public sector wage bill;
- Social transfers; and
- Debt service costs.
Nedbank noted that in 2019/20, bailouts to state companies amounted to R59.8 billion and accounted for 18% of the main budget shortfall. They totalled R187.4 billion between 2000/01 and 2019/20, with most of the amount going to Eskom.
The latter three points have taken up more than 70% of main budget revenue over the past decade, Nedbank said, and the figure will exceed 95% in 2020/21.
Notably, the revenue plunge as a result of the most recent economic turmoil will push the public wage bill to 52% of budget revenue, while higher transfers to households will also contribute.
“This proportion excludes the planned reduction of the national wage bill by a net R600 million, which, if achieved, will have only a negligible effect on the R567 billion consolidated wage bill,” the bank said.
Few options on the table
Nedbank said that if government fails to consolidate public expenditure, its ability to finance the budget deficit through local currency bonds will take a heavy hit, adding that foreign bond holders have already significantly reduced their exposure to government bonds.
Data points to foreign investors not returning to South African shores speedily as it is, and with the country’s poor growth outlook, all the effort needs to be placed on containing public expenditure, it said.
However, this is far easier said than done, and government’s resolve to restrict something like growth in the public sector wage bill and income transfers will be tested ahead of the 2021 local government elections and the 2024 national poll.
“Given limited appetite among foreign portfolio investors for local currencies bonds, failure to reduce spending will leave government with only two funding options: Increase issuance of foreign currency bonds, which carries interest-rate and currency-mismatch risks, or request a fully fledged concessional multilateral facility,” the bank said.
Assessing the political noise around the IMF’s Covid-19 loan, Nedbank said that political resistance to secure a formal IMF facility “will be fierce”. However, in the event of high foreign-currency borrowing costs, the South African government will be faced with limited choices.
“It is therefore increasingly clear that it is time for South Africa to familiarise itself with the corridors of the Washington institutions. Political resistance will only delay what is likely to be an inevitable fate,” it said.
“Fiscal reform will be formidable but not unattainable.”