Dodging the credit ratings wrecking ball

Markets responded positively to Malusi Gigaba’s budget, which predicts a better debt-to-GDP outlook. (David Harrison)

Markets responded positively to Malusi Gigaba’s budget, which predicts a better debt-to-GDP outlook. (David Harrison)

Wednesday’s budget may be just enough to stave off a credit ratings downgrade from Moody’s but it needs to be followed by structural reforms and credible changes to the Cabinet to ensure the budget’s promises are kept, not least of which is a carefully managed public wage settlement, experts say.

Considering the political environment in which the budget was drawn up, the final product was excellent, according to Nazmeera Moola, co-head of fixed income at Investec Asset Management.

Following the dismal medium-term budget policy statement in October, Moody’s placed South Africa on negative watch for a downgrade — with a final review pending in March.

The budget may have been enough to prevent this, said Moola, but whether it is enough to improve Moody’s long-term outlook on South Africa remains to be seen.

Ratings agencies would want more confidence that the new growth measures promised by President Cyril Ramaphosa are going to be implemented, argued Moola.

“The best way to do that is to have people in charge of the relevant departments that must implement this who are plausible, trustworthy and understand policymaking,” she said. Changes need to be seen in, for example, the department of public service and administration, which is leading the talks with public sector unions on behalf of government.

“We need to ensure that the wage settlement comes in sensibly,” said Moola. “If there is slippage on the wage settlement, that derails this whole budget and the current minister doesn’t engender much confidence.”

Ratings agencies have been flagging the need to return the fiscus to a sustainable path by reducing debt levels and the budget deficit, as well as the need to unlock growth.

Agencies S&P Global and Fitch have both downgraded South Africa’s foreign and local currency ratings to junk, but Moody’s is yet to make a decision on whether to downgrade South Africa’s local currency rating — the only one that remains investment grade.

The reductions in the main budget deficit showed a decline from 4.6% this year to 3.7% in 2020-2021. The medium-term budget policy statement indicated that South Africa’s debt-to-GDP ratio would reach the unsustainable level of 60% by 2021-2022.

But thanks to a combination of higher GDP growth, a narrower deficit, a stronger currency and lower borrowing rates, the 2018 budget predicts a better debt-to-GDP outlook, with debt stabilising at 56.2% of GDP in 2022-2023.

The markets responded positively to the budget numbers — the rand strengthened to new highs against the dollar and government benchmark bond yields dipped to below 8% for the first time in almost three years, according to Bloomberg.

Tax increases to raise an addition R36‑billion this year as well as expenditure cuts of about R85‑billion have also helped to shore up the government’s financial position. But the cuts have raised red flags because spending has shifted dramatically from capital expenditure and investment in infrastructure towards current spending on items such as wages.

This is out of line with long-term efforts under former ministers such as Pravin Gordhan and Nhlanhla Nene to redirect government spending towards investment in growth.

The treasury warned that a wage agreement that locks in salary increases that exceed consumer price index inflation would make expenditure limits difficult to achieve. The government’s wage bill has increased from 32.9% of spending in 2007-2008 to about 35% of all spending in 2017-2018.

“Improving the composition of spending will require renewed efforts by government to manage the public-service wage bill,” the treasury said.

It added that research showed that South Africa’s government wage bill is one of the highest among its developing country peers. Over the coming three years, it has pencilled in an increase to the consolidated wage bill of 7.3%.

Mamello Matikinca, chief economist at FNB, said the numbers outlined by the budget should be enough to prevent a ratings action by Moody’s.

“However, we are concerned by the drastic shift in expenditure, which now leans more to consumption than capital expenditure,” she said in a report on the budget.

“If maintained, the government could potentially be setting itself up for further downgrades down the line.”

If the budget fails to convince Moody’s and South Africa is downgraded, this will have a material effect on the fiscal framework.

The treasury calculated that government bond yields would rise by 100 basis points.  As a result, economic growth would slow to 0.7% in 2018, 1.3% in 2019 and 2% in 2020, thanks to higher borrowing costs and lower investment and consumption.

Structural reform would be needed to unlock growth, Matikinca said, adding that this would involve all state departments. It would also require the alignment of the country’s policy trajectory with that of the National Development Plan.

“With an increased tax burden, it is vital that reforms that lift growth are hastily implemented,” she said.

In the budget review, the treasury highlighted that, if South Africa is to take advantage of improved investor and business confidence, it needs to unlock sectoral reforms. It identified a number of areas, including telecoms and mining, where policies that support investment and transformation are needed.

According to the treasury’s calculations, reforms to the telecoms sector, namely releasing additional spectrum, could potentially add an additional 0.6%.

Along with other reforms, this could potentially take South Africa’s growth to 3.5% from the current expected growth of 1.5%.

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