finweek

MTBPS: Debt, deficits and possible downgrades

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Minister of finance Malusi Gigaba has unveiled a bleak outlook for South Africa’s economy and public finances over the coming three years, painting a stark picture of both the risks to his projections and the impact of any further downgrades to the country’s credit ratings – an outcome that looks increasingly likely.

In his maiden mid-term budget on 25 October Gigaba warned that if South Africa’s local currency credit ratings were downgraded to junk, the country could plunge into a full-scale recession in 2018 and 2019, with capital flight pushing borrowing costs up sharply, hitting the rand and igniting inflation. 

Keeping the investment-grade status of local currency credit ratings is crucial for SA as without it government bonds will fall out of key global bond indices, which would trigger forced selling by foreigners to the tune of $10bn. 

Non-residents hold 40% of the country’s rand-denominated debt. 

If there were more limited consequences to that outcome, economic growth would nonetheless fail to exceed 1% over the next three years and the government’s debt costs – the fastest-growing component of its Budget – would still climb, according to National Treasury’s fiscal risk analysis. 

Standard & Poor’s kept the country’s local currency rating at the lowest rung of the investment-grade ladder when both it and Fitch relegated SA’s foreign currency credit ratings to junk, after President Jacob Zuma’s sweeping Cabinet reshuffle in March. 

But the rating has a negative outlook, which means that the next move will probably be downwards.

Moody’s local currency credit rating is at the same level, also with a negative outlook. 

All three rating agencies are due to deliver their next assessment of SA’s credit-worthiness at the end of November, so their reaction to Gigaba’s mid-term budget will be crucial.

“We are going to have a conference with the rating agencies later today and further meetings with them next week – I wouldn’t want to speculate how they are going to react,” Gigaba told the media before presenting his mid-term budget in Parliament. 

“We will talk very candidly with them – out of every tough situation there are opportunities. It’s in our hands to change the course we are currently on, it is required that we increase the pace and scope of structural reforms.” 

But downgrades in November may be hard to avoid, given all the negative news in the Medium-Term Budget Policy Statement which Gigaba delivered to Parliament, together with the absence of convincing measures to pull the country out of its low growth trap, and generate enough revenues to restore public finances to health.

The budget deficit and debt projections were worse than most analysts had anticipated, with a R50.8bn shortfall in tax revenue – the biggest since the recession in 2009/10 – expected to push the deficit out to 4.3% of GDP in the financial year which ends in March. 

The forecast was 3.1% of GDP in former finance minister Pravin Gordhan’s February budget. 

Gigaba sees the shortfall narrowing to 3.9% over each of the coming three years – a significant deterioration from estimates in February of 2.8% for 2018/19 and 2.6% for 2019/20. Even more ominously, he warned that public debt as a ratio of GDP would balloon to nearly 60% by 2020/21, and might not stabilise without faster growth or additional steps to narrow the budget deficit.

In February, that key ratio was expected to stabilise at around 53% in the medium term. 

Treasury estimated that stabilising gross debt below 60% over the coming decade would require spending cuts or tax hikes amounting to 0.8% of GDP – which in 2018/19 would amount to R40bn.

But Gigaba declined to speculate on tax measures for next year, which are normally revealed in the February Budget. 

“I may feel we need more taxes but […] it would be premature to make assumptions now,” he said in the embargoed media conference. 

For the moment Treasury plans to dig its way out of the debt hole by drawing heavily down on its contingency reserve, reducing it to R16bn for the next three years – much smaller than in previous spending cycles. 

“This diminishes the government’s capacity to respond to spending risks,” it said. 

Lower payments to the Southern African Customs Union over the coming two years will help offset tax revenue shortfalls, being set to fall by R14.1bn in 2018/19 and R19.8bn in 2019/20 in response to weaker-than-anticipated imports and household spending. 

As expected, Gigaba slashed official growth forecasts, estimating them at 0.7% this year, 1.1% next year, 1.5% in 2019 and 1.9% in 2020 – in line with independent forecasts.

Gigaba was blunt in his delivery of the bad news. “We are giving an honest view of the challenges facing our country. 

It is not in the public interest to sugar-coat the state of our economy and the challenges we are facing,” he said in his speech to Parliament.

“The period ahead is not going to be an easy one. Our resolve is to remain on course and not to deviate irretrievably from the fiscal consolidation agenda we embarked on a few years ago,” he added.

Mariam Isa is a freelance journalist who came to SA in 2000 as chief financial correspondent for Reuters news agency after working in the Middle East, the UK and Sweden, covering topics ranging from war to oil, as well as politics and economics. She joined Business Day as economics editor in 2007 and left in 2014 to write on a wider range of subjects for several publications in SA and in the UK.

This article originally appeared in the 2 November edition of finweek. Buy and download the magazine here.

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