On 25 October, South Africa’s (Baa3 negative) Finance Minister Malusi Gigaba presented the country’s medium-term budget, which signals a marked credit-negative departure from earlier fiscal consolidation efforts.
The medium-term budget policy statement (MTBPS) revealed sizeable slippage in fiscal revenue (estimated by the National Treasury at 1.1% of GDP) in fiscal 2017, which ends 31 March 2018, relative to the February budget. The revenue shortfall is a key driver behind the National Treasury’s projections for the headline fiscal deficit of 4.3% of GDP in fiscal 2017, the highest level since 2009 and a substantial increase from 3.4% in the budget presented in February 2017.
Significantly, the MTBPS envisages budget deficits remaining at 3.9% of GDP over the next three fiscal years, in contrast with targeted gradual fiscal consolidation tabled in the February budget. As a result, the National Treasury now expects accelerated accumulation of public debt, and expects public debt to GDP to exceed 60% of GDP by fiscal 2021, a notable departure from the debt stabilization objective outlined in the February budget.
Concurrent with the debt burden increasing almost 7% annually between fiscal 2016 and fiscal 2020, the cost of borrowing has risen. According to Treasury projections, the interest burden will be 15% of revenue by 2020-21, which exceeds the 9.8% median of similarly rated sovereign peers. In our view, at this level, the cost of debt servicing is crowding out pro-growth expenditures while raising mandatory recurrent spending.
The absence of fiscal consolidation both in terms of containing the fiscal deficits and reducing mandatory recurrent spending is credit negative, undermining debt sustainability and eliminating room for deploying fiscal stimulus in the event of a negative economic shock. Fiscal risks stemming from the relatively rapid debt increase are exacerbated by a continued increase in government guarantees to state-owned enterprises, where almost half is concentrated in Eskom, which generates 95% of South Africa’s electricity.
Moreover, the lack of fiscal consolidation in the budget is also a setback to already feeble business confidence and growth. The lack of fiscal prudence indicated by the budget will undermine growth in an economy in a recession since first-quarter 2017 with weak economic activity, according to recent high-frequency indicators.
The current MTBPS is the first fiscal policy document (i.e., budget or mini-budget) in the past several years that does not have the objective of fiscal consolidation.
In our view, unless the government presents a credible fiscal consolidation plan in the February 2018 budget, debt sustainability is at risk.
However, with lower levels of revenue than formerly projected, the thrust of the adjustment would need to come from the expenditure side, which will be challenging to achieve amid rising spending pressures in the run up to 2019 elections.
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