SA’s 2017 MTBPS: A fixed income perspective

PUBLISHED: Tue, 24 Oct 2017 11:04:35 GMT

James Turp | ABSA Asset Management

Finance Minister Malusi Gigaba’s Medium Term Budget Policy Statement (MTBPS) on October 25th will come under intense scrutiny as it is the first opportunity for the Minister to demonstrate his performance in the position.

Historically, the MTBPS has been seen as a useful scorecard for progress made on the February budget. It provides detail on government’s spending priorities, sets out fiscal objectives over the medium term (three years) and sketches government’s take on the South African economic context.

Having recently emerged from a technical recession and with real economic growth projected at 0.6% for 2017 following from the mere 0.3% in 2016, the country is growing way below its potential and conspicuously in contrast to global growth trends.

Many observers will be looking out for the degree of its consistency with the February budget, tabled by former Finance Minister Pravin Gordhan, and whether any introduced measures are ratings agency and investor friendly, as well as what progress has been made on inclusive growth deadlines.

As fixed income investors in South African Government debt, we will naturally be observing the important fiscal metrics that indicate the health of the fiscus – which are expected to have slipped significantly since February; at the worst rate since the 2009 global financial crisis.

In a large part, 2009’s slippage was related to the global situation but 2017 is in contrast as negative global output gaps are generally closing. South Africa is an obvious exception to this trend.

In trying to explain why South Africa is missing out on the global recovery, the South African Reserve Bank, in its October 2017 Monetary Policy Review, attributes this to two main factors: lower commodity prices (largely outside government’s ability to influence) and subdued consumer confidence (a proxy for general confidence and a factor that is influenced by government policies and behaviour).

Their analysis indicates that subdued confidence levels alone removed 115 basis points from GDP growth in 2016 (i.e.0.3% realised instead of 1.45%).

It follows that actions taken to influence confidence are critical to address this low growth paralysis. As a result, the MTBPS becomes a far more interesting and powerful event which could provide a much needed boost to confidence levels, and positively influence investor, business and consumer behaviour via discretionary spending and also labour and capital productivity.

Minister Gigaba should use the opportunity to announce actions that to improve confidence, to address this low growth paralysis and positively influence investor, business and consumer behaviour.

Focus will be on the size of the revenue shortfall, forecast to be anywhere between R25 to R50 billion, having widened due to the lower realised economic growth, apparent revenue collection inefficiencies, lower tax buoyancy and disappointing receipts from the international tax amnesty.

The delicate act of raising revenue against this backdrop of a struggling domestic economy will be difficult. It is thought that an extra R25 billion of revenue could be required.

Higher personal income tax rates or customs duties could undermine economic growth. As a result, it is possible that the lens will turn to medical aid tax credits, VAT zero ratings, petrol and municipal rates.

According to the February Budget, debt/GDP was expected to peak at 52.9% at the end of 2018/19 budget year. This now seems unlikely given the much eroded fiscal space that has various consequences.

The figures show that South African government debt levels are already in line with non-investment grade countries (BB). Although South Africa’s high proportion of domestic currency debt has its benefits, when contingent liabilities and State Owned Entity (SOE) debt are included these levels approach 75% of GDP as seen below (Figure 1).

Figure 1: Debt ratios: sovereign credit rating comparison (sources National Treasury and S&P Global ratings).

The funding cost of government debt needs to be lower than nominal GDP growth to assist in reducing the debt burden. The term structure of National Treasury’s issuance is expensive as they attempt to secure long term debt on a steep yield curve.

One could argue that taking bold steps and rolling funding along the shorter area of the yield curve could be more prudent even if less comfortable for the issuer.

Possibly the biggest issue at present is the source of funding for SOEs going forward.

With economic growth negatively impacted, in particular by the severe low levels of confidence, what remedies are immediately available to provide the much needed shot in the arm?

Though implementation of policy is complex, the mere signal of intent would be enough to raise confidence levels quickly. Suggestions of a 1% VAT increase, which could add as much as R20 billion to the revenue, would arguably do more and benefit the economy over the longer term as a consumption tax.

Diversifying trade agreements and strategies away from commodity dependent trading partners where possible could be considered. The elephant in the room, however, remains the severe loss making SOEs which could be aggressively addressed in steps such as the outright liquidation of the national airline or the selective sale of Eskom’s generation and distribution assets – though it is unlikely that these are available options.

This MTBPS will be closely monitored by ratings agencies, international investors and domestic businesses/entrepreneurs as well as the general public.

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