TICKLING A NERVE
The 7% public sector pay increase is positive from a fiscal consolidation and rating agency perspective
Thabi Leoka column
After almost a month of long and tough wage negotiations, government and unions finally agreed on a 7% increase backdated from April. In the second and third year of the agreement, salaries will be adjusted by the projected average CPI plus 1%.
In this year’s budget government planned a 6,6% nominal annual average increase over the medium-term expenditure framework (MTEF) period and 7,6% in the 2015-16 financial year. The new wage agreement of 7%, from 5,8% previously, includes an addition of R300 to the housing allowance of R900. Medical aid benefits will rise 29%.
From a fiscal consolidation perspective, the wage increase is in line with the MTEF target, assuming that the CPI remains in the target band. Treasury says a 10% wage increase, which is what unions were asking for, could have put an extra R50bn burden on the budget, which could have increased the 2015-16 deficit to about 4,5% of GDP, versus the current 3,9% target. The public sector wage bill is about R400bn and it is expected to increase to about R440bn in 2015-16. So the 7% increase is positive from a fiscal consolidation and rating agency perspective.
Ratings agencies have in the past criticised government for accommodating wage increases at the expense of capital spending. If the current settlement had departed greatly from inflation, government would have had to cut capital expenditure substantially, introduce more stringent controls on public employment or curtail spending on other critical priorities. This would be negative for SA’s outlook, particularly from a ratings perspective.
It is therefore unlikely that Fitch and Moody’s will downgrade SA’s sovereign ratings (Fitch from BBB to BBB- and Moody’s from Baa2 to Baa3) this year.
But government faces another problem: state-owned enterprises.
Standard & Poor’s (S&P) downgraded Eskom to BB+ from BBB- on March 19, following the suspension of the company’s CEO, its CFO and two senior executives, saying it had less confidence in Eskom’s corporate governance arrangements and its standalone profile. I believe Eskom faces significant risk of a further downgrade by S&P and Moody’s. Revelations of political interference and corruption at Eskom since the S&P ratings downgrade and extended load-shedding owing to capacity constraints will likely compel rating agencies to reassess their ratings on the utility.
Furthermore, increased load-shedding, including escalations from stage two to stage three owing to units going out of service, will contribute to economic drag and tarnish sentiment. According to a recent Moody’s assessment of SA, deteriorating public finances in advance of inevitable interest rate increases are a critical weakness. Moody’s has also rightly pointed out that severe electricity shortfalls are limiting growth and affecting investor sentiment.
Increased load-shedding has also meant that industrial users have had to reduce their usage by 10%. On average, the shortfall between supply and demand has been 3 000 MW. Eskom’s total nominal capacity is about 42 000 MW. To make matters worse, workers at the Medupi plant have been on strike for more than four weeks, which will likely delay the synchronisation of its unit six. Labour disturbances and technical errors at the plant have multiplied costs, which is expected to amount to R114bn, according to Eskom.
While Eskom’s recent announcement of its intention to interrupt bulk electricity supply to the 20 largest defaulting customers is a positive move, I remain concerned by the extent to which total municipal debt has risen (from R3,5bn reported in the first half-year interim results ending September 30 2014, to R4,6bn at March 31 2015.) Interestingly, the 20 largest defaulting municipalities have been run by the ANC since the 2011 elections, which will make it difficult for the ruling party to solve the growing debt problem while making sure it keeps its constituencies.
The next ratings decision may not take SA to junk status; however, the lack of urgency and the growing number of problems can easily lead the country to noninvestment-grade territory in the not too distant future.
Electricity shortfalls are limiting growth and are having an impact on investor sentiment