Carmen Nel, Economist and Macro Strategist, Matrix Fund Managers
Finance Minister Enoch Godongwana’s second Medium Term Budget Policy Statement (MTBPS) painted a very positive picture of the medium-term fiscal position. Not only does the National Treasury intend to move to a primary budget (revenue less non-interest expenditure) surplus in FY23/24, it aims to grow the surplus over time. In so doing, it hopes to stabilise the debt ratio at 70% of GDP in the medium term, and to outright lower the ratio from FY26/27 onwards.
We think there may be too much optimism embedded in these projections. This may be merely a placeholder budget, albeit on the bullish side of the risk distribution, given significant events between now and the February 2023 Budget Statement. Importantly, the ANC elective conference in December would affect the politics of the February budget, which may have constrained the ability and willingness to be more explicit on certain expenditure or revenue items. In addition, the Financial Action Task Force (FATF) grey-listing process is set to be concluded by February, which may also have received outsized attention in the lead up to the MTBPS.
The presentation of the current fiscal year was more realistic. The tax revenue overrun is estimated at R83.5bn, with the bulk coming from corporate income tax receipts, which is no surprise in light of elevated commodity prices and strong earnings rebound. Yet, more broadly, revenues have been doing well thanks to the wage recovery, better import growth, and stronger VAT receipts (even when adjusting for refunds). The deficit was revised from 6.0% of GDP to 4.9%, which was within the consensus forecast range. The market may find it difficult to believe that the government will be able to narrow the deficit to 3.2% of GDP by FY25/26.
There are few reasons for circumspection:
· The Treasury expects growth to hold up (around 1.8% over the medium term) despite the current slowdown in the global economy, with some of the world’s largest economies – such as Germany and the UK – already skirting with recession. As growth in China and the US move well below trend, it is difficult to see how SA’s growth will hold up when we add in domestic monetary policy tightening and what seems to be a commitment towards fiscal consolidation.
· Linked to more sustained, albeit still pedestrian, growth, the revenue overrun is carried forward to a large extent, which assumes either a longer-term tailwind from elevated commodity prices or better revenue collection elsewhere. While we agree that capacity rebuilding at SARS is bearing fruit, it may be a tall order to rely on this to sustain revenue at over 25%/GDP, which is well above the pre-Covid level of around 23.5% – 24.0%.
· The FY23/24 numbers include the extension of the SRD grant (for 12 months to March 2024), but there is no provision thereafter for a permanent replacement grant.
· The FY22/23 wage bill does not reflect the current, albeit partly, settled wage agreement of a 3% increase over and above the 1.5% pay progression and cash gratuity.
· The Eskom debt swap is still short on detail and these additional funding costs are not yet included in the medium term expenditure framework. Granted, the debt transfer should limit the need for further equity injections and so reduce the funding associated with bailouts, but the debt that the government will take on will be more expensive than that issued by the government directly and so will add to the debt service bill.
But some room for comfort
Admittedly, there is a small cushion built into the numbers with unallocated reserves of R41.3bn in FY24/25 and R47.3bn in FY25/26.
There was conditional state-owned enterprise (SOE) support of R23.7bn for SANRAL, R5.8bn for Transnet, and R3.6bn for Denel. However, Eskom did not receive additional funding over and above what was budgeted in February. The government has committed to a debt swap with a vague quantum of around R130bn – R260bn, but given the composition of Eskom’s debt – ranging from ZAR to USD denominated, guaranteed to unguaranteed, and listed to DFI loans – ironing out the details will be no easy task.
The fixed income market might be somewhat disappointed by the lack of detail on the Eskom debt swap, as well as the fact that domestic fixed-rate and inflation-linked bond issuance will be left unchanged. Rather, the revenue overrun and excess cash balances will be used to lower foreign borrowing, as well as floating-rate issuance. This is potentially a missed opportunity for the government to lower the supply indigestion in the domestic bond market, given that issuance is being done at a substantial discount compared to a relatively tight spread on the 5-year government floating-rate note. Alternatively, the government may use the floating-rate note as a flexible issuance tool on an ad hoc basis and give the market certainty in keeping the fixed-rate and inflation-linked bond issuance unchanged.
Expenditure ceiling raised … again
The overarching negative message from the MTBPS was that the commitment to the expenditure ceiling should be questioned, as this has turned into a soft rather than a hard fiscal rule. It has been raised yet again, by R51.6bn in FY23/24 and R57.9bn in FY24/25. In addition, the line in the sand on SOE support has again been crossed.
Where we could be too pessimistic is on medium-term fixed investment growth and the government’s ability (and willingness) to crowd in the private sector. A stronger growth outlook would also be more plausible if there is clear evidence that deep-seated reforms are accelerating.
Overall, markets react positively
On the surface it looks as if the markets reacted positively to the MTBPS, but closer inspection reveals that the rally in SA’s bond yields have been driven more by the decline in US yields, while the stronger rand has been a function of the weaker dollar.
Within equities there seems to be more evidence of the beneficial budget, with banks doing relatively well, but on the whole, the local bourse as has also benefited from lower US bond yields, a weaker US dollar, and higher commodity prices.
Even though offshore drivers are dominating local market performance in recent trading sessions, this budget may be enough to keep the bond vigilantes at bay until the hard decisions are taken.