4 tough questions that Mboweni will need to answer in the budget next week
When President Cyril Ramaphosa delivered his State of the Nation Address (Sona) last Thursday, he once again maintained that the country would not achieve higher rates of growth and employment, without the implementation of structural economic reforms.
Going into this year’s National Budget Speech, Finance Minister, Tito Mboweni will likely echo the same sentiments, says Ricardo Smith, investment strategist at Absa Global Investment Solutions.
“South Africa currently finds itself confronted with serious fiscal challenges. Spending continues to outpace tax revenues, forcing the government to tap lenders to plug the budget deficit.
“Unfortunately, credit ratings downgrades and the ensuing capital market outflows, have not helped restrain South Africa’s cost of borrowing, nor have they assisted in stabilising the ratio of debt-to-gross domestic product (GDP).”
Smith said that this raises a number of questions, including:
- How does a government that is struggling to churn out decent economic growth – even before the devastation of the Coronavirus (Covid-19) pandemic – successfully gets its rising debt under control?
- Does it shift spending from consumption to investment?
- Will it ease the pressure on public finances, when reforming state-owned entities is still proving a challenge?
- How does the government grow its purse when the Covid-19 induced restrictions on the economy are making it that much more difficult to address the chronic unemployment rate?
Investment strategy
Notwithstanding deteriorating government debt levels, a widened fiscal deficit and credit ratings downgrades, Smith said that Absa maintains a significant allocation to local fixed-income securities.
“This is due to above-inflation real yields to maturity, attractive coupon rates and alternative systematic risk to equity markets, allowing for diversification,” he said.
“However, within this asset class, we are weary of potential yield slippage on the longer-end should the fiscus deteriorate further. We therefore advocate for a duration-neutral strategy within local fixed-income securities.”
In terms of local listed equity markets, Smith said that Absa is of the view that market valuations are stretched at current levels without earnings growth coming to the fore.
“Markets have aggressively priced in an economic recovery coupled with strong positive earnings growth. Should economic growth and corporate profitability levels not meet market expectations, listed equity markets will take back some of their recent gains.
“Whilst maintaining significant exposure to listed equities, we have also implemented derivative hedging strategies to protect our portfolios from sharp drawdowns as well as moderate cumulative negative returns.”
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