Fitch Ratings-London/Hong Kong-26 June: The South African government’s intention to stabilise debt levels within four years, as set out in this week’s emergency budget, is unlikely to be achieved, Fitch Ratings says. This reflects persistent challenges in reducing expenditure, boosting growth and insulating public finances from struggling state-owned enterprises, as well as reflecting the impact of the coronavirus pandemic, which will drive a sharp rise in debt/GDP this year.
Wednesday’s emergency budget revised the consolidated budget deficit projection for the current fiscal year (FY21; ending March 2021) to 15.7% of GDP, over double the 6.8% projected in the original budget in February. The main factor is a sharp fall in tax revenues due to the economic fall-out resulting from lockdown measures, as well as the general hit to the economy and some tax relief. The government expects the main budget revenues to be ZAR300 billion – 6% of GDP – lower than previously anticipated.
South Africa has recorded 100,000 coronavirus cases and this number could rise substantially, according to government modelling. Nevertheless, the government expects non-interest expenditure to be just ZAR36 billion (0.7% of GDP) larger than projected in February, as the emergency budget plans to offset substantial additional spending on health and economic support through savings in other areas.
We view the government’s forecast of gross loan debt rising to 81.8% of GDP in FY21, much higher than the 65.6% in the original budget, as realistic. However, we believe its expectation that debt will peak at 87.4% in FY24 is optimistic. This would require sufficient fiscal consolidation to achieve a primary budget surplus in that year, which would be South Africa’s first since 2008, towards the end of the commodity boom.
The government aims to cut expenditure by ZAR230 billion over FY22 and FY23 relative to earlier plans and then implement additional cuts, complemented by small tax-raising measures. Details will be presented in the Medium-Term Budget Policy Statement in October.
Revenue projections beyond the current fiscal year appear conservative, and revenues may exceed government forecasts (the government predicts that revenues will still be ZAR202 billion below its February projections in FY23). However, Fitch believes planned expenditure cuts seem ambitious not least because they would significantly weaken the economic recovery. South Africa’s recent experience highlights the challenges of meeting fiscal targets. February’s budget abandoned the earlier target for a primary budget balance by FY23 (excluding support for state-owned electricity company Eskom).
Social and political factors, including exceptionally high inequality, powerful trade unions and deep divisions within the governing African National Congress, present significant hurdles for spending cuts. For example, the government has still not agreed the wage bill savings with public sector trade unions for FY21 that were included in the February budget. A comprehensive adjustment of the large public sector wage bill may not be possible until the current three-year agreement expires in April 2021, and negotiations then are likely to be difficult.
Key reforms to Eskom that would support the economy and reduce the burden on the public finances, and relatively minor measures to accelerate GDP growth, have also faced significant political hurdles. Although the challenges in restructuring state-owned flag carrier South African Airways, which filed for business rescue protection last December, are small from a macroeconomic standpoint, they illustrate the difficulty in addressing budget pressures from troubled state-owned enterprises in the face of trade union opposition. Our downgrade of South Africa’s Issuer Default Rating to ‘BB’ on 3 April resulted from the lack of a clear path towards government debt stabilisation as well as the expected impact of the coronavirus pandemic-related shock on public finances and growth. The Outlook on the rating is Negative. A continued rise in government debt/GDP and failure to formulate a clear and credible path towards stabilising the government debt/GDP ratio could lead to negative rating action