South Africa is in a hole, financially, following years of fiscal mismanagement under corruption under the previous presidential administration.
Just how much of a hole we are in will likely be revealed next week, when finance minister Tito Mboweni presents the 2020/21 Budget Speech.
Old Mutual Investment Group chief economist, Johann Els, believes that while the budget is the most important in 26 years, whatever its contents, it will not be enough to stave off a Moody’s credit rating downgrade in March 2020.
“However, consumers and investors need not panic as the downgrade has largely been priced in the market,” he said.
What needs to be done
Els compiled a brief list of what needs to be done to appease the market, and at the very best case, keep Moody’s at bay for at least a little while.
- At the very least, deliver on MTBPS fiscal consolidation plans;
- Achieve primary balance (excl Eskom support) by 2022/23;
- Cut expenditure by R150 billion over next three years.
But, to avoid downgrade, do more…
- Large expenditure cuts and limit wage bill growth;
- Tax hikes also needed;
- Get deficit ratio back towards 4.5% in 3 year’s time (vs MTBPS target of -5.9%);
- Show credible path towards debt ratio stabilisation around 70% to 75%.
What will likely be done…
- Some spending cuts; nothing on wage bill this year (maybe some promises for next year);
- Some tax hikes;
- Deficit still around 6% to 5.5% in 3 year’s time;
- Debt ratio still rising towards 80%, no stabilisation.
The Budget deficit climbed to 6% of GDP last year, with extra spending on Eskom adding strain to the public purse, which is already stretched.
“Treasury has not been able to rein in the budget deficits over the last few years, so it is really now or never.
“We are on the verge of a Moody’s rating downgrade, and if we don’t stabilise the deficit and get spending under control, they will downgrade us,” Els said.
South Africa is reeling from five consecutive years of less than 1% average GDP growth, which has harmed the deficit and the debt burden.
“We pay more than R200 billion a year on interest payments alone – which is more than the annual budgets of health, education and police services,” said Els, adding that South Africa needs annual economic growth of 2.5-3% to stabilise the debt ratio and prevent a debt trap.
Debt to GDP has shot up from 26% in 2009 to 60%, and this is making it difficult to service debt, with interest on debt already 11% of total expenditure, the economist said.
While there will be an attempt to reduce additional spending, cutting back on the wage bill would be advantageous; however, this is not likely.
“This will be difficult to pull off politically and would need to be negotiated with unions, but potentially it could be a big game-changer: just limiting wage bill growth to 4% could save R100 billion. While the intention in the Budget must be on the spending side, I am doubtful that the Finance Minister will be able to do enough,” said Els.
As a result, Els expects a Moody’s credit rating downgrade in March 2020. “I expect a downgrade to junk status – and thus exit from the World Government Bond Index (WGBI),” he said.
Reasons to be positive
Els said that while a downgrade will not derail the economy, its timing is dependent on Treasury’s ability to convince Moody’s of a future fiscal path. The economist said that president Cyril Ramaphosa has done a lot of ground work to ensure a better outlook for South Africa.
“Gradually these improvements will lift confidence,” he said. A new president has brought with it a new administration, and a better cabinet.
Els said that contentious issues such as land reform, while handled slowly, they have been dealt with in a relative transparent and responsible manner.
The economist said that much work is being done to fix the state, with ongoing focus on the National Prosecuting Authority (NPA) and protecting the South African Revenue Service.
Treasury under Tito Mboweni, is being rebuilt and is gaining in confidence and strength, Els said.
Els conceded that while much work needs to be done to fix the country’s state owned enterprises, government is getting on with the task at hand, particularly around Eskom and SAA.
Additional contributing factors to a better outlook for South Africa:
- Fighting corruption – some acceleration recently in NPA cases; commissions ongoing;
- Keeping institutions strong – highlighted in World Economic Forum’s Global Competitiveness index;
- Policy debate started (Treasury’s economic plan) – debate ongoing, no implementation yet;
- Visa deregulation has happened and is ongoing;
- Better growth – foundations are being laid;
- Low inflation – helps consumers;
- Lower interest rates – little direct or immediate impact on real economy, but could help confidence.
Key strengths for South Africa include the fact that it remains a constitutional democracy with an independent judiciary, a free media and a country with vigorous public debate, Els said.