Why rating agencies won’t be happy with the budget

PwC Strategy& economists Lullu Krugel, and Christie Viljoen see a high probability of Moody’s Investor Service downgrading South Africa to non-investment grade this year, despite an encouraging Budget Speech 2019, delivered by finance minister Tito Mboweni to Parliament on Wednesday, 20 February.

“His address was forthright about the challenges facing the country, and while there were many bitter pills to swallow in the detail, the minister provided some good news – for rating agencies – on key subjects like Eskom and the public sector wage bill,” Krugel said.

“These sweet words, depending on whose ears it falls, can, however, not detract from the wide budget deficit and huge debt that the public sector is struggling with,” the economist said.

National Treasury revised down the South African economy’s growth to 1.5% in 2019. In the 2019 Budget Review document on Wednesday, Treasury said Gross Domestic Product (GDP) has been revised down since the Medium Term Budget Policy Statement (MTBPS) tabled in October 2018.

The document attributed the drop in forecast from the 1.7% tabled at the MTBPS to 1.5% – to a fragile recovery in employment and investment, and a less supportive global trade environment.

“The weaker outlook projects a slow improvement in production and employment following poor investment growth in 2018, and a moderation in global trade and investment. The medium-term outlook is subdued, with GDP growth projected to reach 2.1% in 2021, supported by a gradual improvement in confidence, more effective public infrastructure spending, and a better commodity price outlook than previously assumed,” noted the document.

This as South Africa’s GDP growth slowed from 1.3% in 2017 to an estimated 0.7% in 2018.

Revenue boost from personal income tax

PwC noted that gross tax revenue projections for 2018/19 have been revised lower by R15.4 billion (1.2%) compared to MTBPS estimates. Around half of this is due to higher-than-expected VAT refunds, with the remainder contributed to lower tax collections, driven to a large extent by disappointing tax collections from companies and personal income taxes.

In response to ongoing concerns over the underperformance of collections by the South African Revenue Service (SARS), Minister Mboweni indicated that the Davis Tax Committee would investigate the gap between revenue collected that taxes that should be paid.

Reducing the public wage bill

Minister Mboweni acknowledged what most local economists have been saying for a long time: that the public sector wage bill is unsustainably large. “As a result, he is cutting national and provincial compensation budgets by R27 billion over the next three years,” Krugel said.

Most of these savings will come from early retirement options for older employees, with details to follow in coming weeks. Furthermore, Members of Parliament (MPs), provincial legislatures and executives at SOEs will not be receiving remuneration increase in this year, PWc said.

Public entities are also encouraged to freeze the salaries of workers earning more than R1.5 million rand per annum in the 2019/20 fiscal period, it said.


A key focus area in this year’s budget speech is the financial support that has been set aside for Eskom and the Infrastructure Fund. “Because of these and other changes, the 2019/20 fiscal year is expected to see consolidated expenditure of R1.83 trillion, equal to a hefty 33.7% of GDP, the PwC economists pointed out.

Debt service costs will remain the fastest growing spending point, forecast to grow by an average of 10.7% per annum during 2019/20-2021/22.

“Pouring money directly into Eskom in its current form is like pouring water into a sieve,” Mboweni said on Wednesday. However,  the government will set aside R23 billion per annum to financially support the reconfiguration of the power utility.

“This money is contingent on the appointment of an independent chief reorganisation officer (CRO) at Eskom to deliver on the reconfiguration and other recommendations made by a presidential task team about the matter. The minister made it clear that the state will not take over any of Eskom’s debt,” Krugel said.

Budget deficit

The country’s budget deficit will plikely widen to the worst in a decade as declining economic growth, falling tax revenue and debt-laden state-owned companies weigh on public finances, Bloomberg reported.

The National Treasury forecast a fiscal gap of 4.5% of gross domestic product for the year starting April 1, making it the worst since the 6.3% reported in fiscal 2010, and bigger than the estimate in a Bloomberg survey.

Bloomberg said that the deteriorating outlook will test Moody’s appetite to maintain the nation’s sole investment-grade credit rating, with its next review due March 29.

“A downgrade would exert further pressure on an economy that hasn’t expanded by more than 2% since 2013.“I said that we were at a crossroads, and that we could go either to heaven, or the other way,” Mboweni said in a written copy of his speech.

Ratings agencies

Rating agencies will likely to be unhappy about deteriorating fiscal metrics, PwC said.

“While minister Mboweni did not spend any time in his speech talking about ratings agencies, they are important – albeit a small set of – stakeholders,” said Krugel.

The sovereign has been downgraded to sub-investment grade by S&P Global Ratings and Fitch Ratings due the deterioration in its fiscal position over the past decade.

“If rating agency Moody’s Investors Service were to also downgrade the debt to sub-investment level, South Africa would be removed from the Citi World Government Bond Index,” the economist said.

“This would prompt asset managers and pension funds to sell billions of rands worth of domestic bonds. This would sharply increase the cost of debt and pressure the exchange rate.”

Rating agencies are likely to be unhappy with the widening of the fiscal deficit, higher projected peak in public debt, as well as increased exposure to the financial woes at SOEs, PwC said. The deterioration in these metrics have been a steady trend in recent years so it would not come as a shock.

“However, rating agencies set thresholds and do peer comparisons to determine whether a country has shifted lower in its creditworthiness to borrow internationally If S&P, Fitch, and especially Moody’s feel this is the case for South Africa, the results could be another bitter pill to swallow.

“In spite of steps to address the Eskom crisis, as well as the public wage bill, PwC sees a high probability of Moody’s downgrading South Africa to non-investment grade this year,” Krugel said.

Read: The 2019 budget in a nutshell

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Why rating agencies won’t be happy with the budget