Fitch warns that MTBPS suggests policy shifts to occur much faster than expected

PUBLISHED: Thu, 26 Oct 2017 14:11:57 GMT

Fitch Ratings-Hong Kong/London-26 October 2017: South Africa’s (BB+/Stable) Medium-Term Budget Policy Statement (MTBPS) projects a sharp fall in fiscal revenue, but has no measures to contain the impact on deficits and debt, Fitch Ratings says. This suggests that the change in direction of policy making away from a focus on fiscal consolidation that we anticipated as a consequence of March’s cabinet reshuffle is under way and occurring faster than we had expected.

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Wednesday’s MTBPS is the first major fiscal announcement since Malusi Gigaba was appointed Finance Minister in March. The government no longer forecasts stabilising debt, having raised its forecast for gross loan debt (its measure of consolidated government debt) to 58.2% of GDP for the financial year to end-March 2020 (FY19/20) from 52.4% previously. It expects a further rise to 60.8% by FY21/22.

This reflects large upward revisions in the Treasury’s consolidated government deficit forecast, to 4.3% of GDP (1.2pp wider than in the February budget) this year with only a moderate improvement to 3.9% next year and no further reduction in the two following years. Previously, the government had projected a decline to 2.6% in FY19/20.

The revisions reflect significant revenue shortfalls, of ZAR50.8 billion (1.1% of GDP) in FY17/18, as a result of lower GDP growth (now predicted to be 0.7% in 2017, down from 1.3% in the budget) and lower-than-expected tax buoyancy (the increase in tax revenues for a given increase in GDP). The government’s GDP growth forecasts are now in line with or lower than Fitch’s. However, there remains a substantial risk of additional revenue slippage if tax buoyancy fails to recover.

The MTBPS also raises questions about the role of the non-interest expenditure ceiling as a key fiscal policy anchor. The statement predicts that spending will exceed the ceiling set in February’s budget by ZAR4 billion in FY17/18, driven by the recapitalisation of South African Airways and South African Post Office. The amount is small at 0.1% of GDP, and the government is looking for ways to make the recapitalisation revenue-neutral so that a breach of the ceiling could still be avoided. But the fact that a breach is included in official projections points to a significant loss of credibility for this policy tool.

There are substantial risks to the ceiling from the expenditure side. Public-sector wage negotiations are under way, with a large divergence between trade union demands and MTBPS wage bill projections. The government also noted that capital injections for other state-owned enterprises (SOEs) are likely as profitability has declined sharply and lenders are reluctant to roll over maturing debt, but these are not included in fiscal projections.

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The SOEs most likely to require injections, such as Denel, South African Express and the South African Broadcasting Corporation, are relatively small and the fiscal impact would be limited. But the document also points to a risk that Eskom, which holds much larger debt of 9.3% of GDP, may require renewed injections if stabilisation measures do not materialise. Gigaba emphasised that a nuclear power programme is not affordable, but the appointment of a new energy minister last week may signal a desire on the part of the government to accelerate a programme.

Proposals to shore up the public finances are being considered by a team of cabinet ministers, with measures to be announced in next year’s budget. But the fact that no agreement on consolidation measures or even headline targets for revenue increases were included in the MTBPS highlights how disagreements in the ANC have made it difficult to agree on savings measures.

We think that divisions in the ANC will persist beyond the party’s electoral conference in December, and it is not clear that the political environment will become more conducive to consolidation. The government also seems increasingly concerned that fiscal tightening measures might dent GDP growth and undermine efforts to rein in deficits.