Nene may abandon deficit targets as downgrade threat looms

South African Finance Minister Nhlanhla Nene may be forced to abandon his budget-deficit targets as economic risks mount, straining the nation’s credit rating as it hovers above junk.

With the economy close to recession, Nene is set to downgrade growth and tax revenue forecasts when he presents his mid-term budget on Wednesday. The target for the fiscal gap in the year beginning April 1 will probably increase to 3.2% of gross domestic product from 2.6%, according to the median estimate of 12 economists surveyed by Bloomberg.

Nene has little room to spur an economy in desperate need of a boost. With debt levels approaching 50% of GDP, credit-rating companies are watching expenditure targets closely. The government is having to scale back spending at a time when mining companies such as Anglo American Platinum are reining in investment and slashing jobs in the face of plunging commodity prices.

“The treasury will have to downgrade South Africa’s growth forecasts yet again,” Nazmeera Moola, an economist and strategist at Investec Asset Management in Cape Town. “The one thing the government cannot do is breach the expenditure ceiling for the next three years that they announced in the February budget.”

The government will probably lower its GDP forecast of 2% for this year and 2.4% in 2016, bringing it more in line with the central bank’s projections of 1.5% and 1.6% respectively. 

Spending pressures
That will curb revenue targets and widen the fiscal deficit unless Nene can reduce expenditure at the same time, a commitment that may prove difficult to make given spending pressures.

The government awarded civil servants higher pay increases this year than had been budgeted, reducing Nene’s flexibility. The minister said in a written reply to a lawmaker on Monday that the additional money for the wage bill will come from drawing down the contingency reserve, using funds available from departments that have underspent and reallocating some resources.

South Africa can ill afford a credit-rating downgrade with interest payments on debt already making up almost 10% of government spending. Fitch Ratings has a negative outlook on South Africa’s BBB assessment, indicating it may cut the nation’s debt from two levels above junk when it publishes its next review in December.

Standard & Poor’s and Moody’s Investors Service have stable outlooks on their ratings. Fitch’s assessment is in line with Moody’s and one level above S&P.

“If government now increases its expenditure significantly it’s going to have to borrow aggressively,” Isaac Matshego, an economist at Nedbank Group, said. “Borrowing aggressively will push our debt stock higher and debt-service costs will go through the roof.”

Yields on rand-denominated government bonds due December 2026 have risen 115 basis points to 8.19% since reaching a 19-month low on 29 January.

Tax collection effort
A strong tax-collection effort this year will probably allow Nene to meet or slightly improve on his deficit target, bringing it down to 3.8% of GDP compared with February’s projection of 3.9%, according to economists surveyed by Bloomberg. 

The shortfall will reach 3% in 2017-18, according to the survey, compared with a previous goal of 2.5%.

Having already raised personal income taxes for the first time in two decades this year, more measures may follow to raise revenue. While major tax announcements aren’t made in the mid-term budget, Nene may cite findings from a government-appointed panel, known as the Davis Tax Committee, which recommended raising the value-added tax rate from 14% rather than increasing individual and company taxes. VAT hasn’t been increased since 1993, the year before the African National Congress came to power.

“Maybe for the current fiscal year there aren’t any big adjustments necessary, but for the next two fiscal years, it might require quite a big reality check” related to tax collection, Gina Schoeman, an economist at Citigroup in Johannesburg, said. “The longer that reality check gets pushed out, the harder it is for the rating agencies to accept.” – Bloomberg

Rene Vollgraaff
Guest Author

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