Moody’s rates SA’s #Budget2020, warns risks remain skewed toward a higher debt path

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By Lucie Villa, Moody’s Vice President – Senior Credit Officer

On 26 February, the Government of South Africa (Baa3 negative) released its budget for fiscal 2020 (year ending 31 March 2021) and for the subsequent two fiscal years. The fiscal trajectory under the new budget is broadly similar to the Medium-Term Budget Policy Statement (MTBPS) presented in October 2019. In the budget, the government has acknowledged that weak economic growth will weigh on revenue intake, which the government has attempted to compensate for by containing spending, particularly on the public sector wage bill. However, it avoided introducing any broad tax-increasing measures given the weak growth environment. As a result, fiscal deficits will remain wide, around 6%-7% of GDP in the next few years, which will increase the government’s debt burden over the budget period. Moreover, uncertainty regarding the success of negotiations with the country’s unions to reduce the wage bill and potential contingent liabilities from state-owned enterprises (SOEs) mean risks to budget forecasts are elevated.

For fiscal year 2020 (the year ending March 2021), the main budget1 balance – the relevant fiscal metric to infer developments in government debt – is unchanged from the MTBPS at 6.8% of GDP. For the overall budget – which is broader – the government plans an overall deficit of 6.8% of GDP, which is higher than the 6.5% presented in the MTBPS. The revision stems from the social security funds balance, which is now recording a deficit equivalent to 0.2% of GDP, from a surplus of 0.1% in the MTBPS, because of legislative changes to the Unemployment Insurance Fund. This deficit will not weigh on the government’s borrowing needs because it will not be financed with debt.

The government has reduced its revenue forecasts to 29.2% of GDP in fiscal year 2020 from 29.3% in the MTBPS and estimates of 29.4% in fiscal year 2019. Expected gains from the carbon tax will offset the revenue loss from above-inflation increase in personal income tax brackets. The government has focused on adjustments to primary spending to compensate for this drop in revenue. Its focus will be the public sector wage bill, where it expects to realize savings of R36 billion (0.7% of GDP) compared with the MTBPS in fiscal year 2020. This would more than offset increases in support to SOEs compared with the MTBPS, especially support to South African Airways.

However, interest expenses will consume an increasing share of revenue at a projected 14.5% in fiscal year 2020, up from 13.5% in fiscal year 2019. Total spending as a proportion of GDP is higher than in the MTBPS (36.0% vs. 35.8% of GDP) and higher than in fiscal year 2019 because of the slower than previously expected nominal growth and higher interest spending.

In subsequent years, the government projects stable revenue, at 29.2% of GDP, which we view as achievable. The budget details further the South Africa Revenue Service’s efforts to improve tax compliance but does not quantify the expected impact of such efforts. Fiscal adjustments will predominantly come from the continued moderation in the wage bill growth, at a Compound Annual Growth Rate of 3.5%, compared with annual inflation of around 4.5% and average nominal GDP growth of 5.9% over the period.

The authorities have yet to negotiate any moderation in wages with the country’s unions, which will likely be challenging given South Africa’s socioeconomic realities and would represent a significant departure from the outcome of previous negotiations. If the government fails to contain the rise in the wage bill and compensation spending increases in line with the MTBPS, we estimate that the fiscal deficit would reach 7.5% of GDP in fiscal year 2020 and 7.1% in fiscal year 2021. The SOE sector, which has been a main source of unexpected spending in recent years, increases the risk of a wider-than-expected deficit.

Even if the government achieves its planned spending restraint, the government’s projected primary deficit of 1.1% of GDP by fiscal 2022 would still be too wide to stabilize the debt burden given weak growth projections and our expectation of a further rise in the interest bill. The budget projects government debt will reach 71.6% of GDP by end of March 2023 (net of the guarantee to SOE debt that we have included in government debt since fiscal 2019), 10 percentage points higher than the level estimated for end March 2020. Risks remain skewed toward a higher debt path given the challenges in containing spending growth and persistent risks to growth.

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