TICK­LING A NERVE

The 7% public sec­tor pay in­crease is pos­i­tive from a fis­cal con­sol­i­da­tion and rat­ing agency per­spec­tive

Financial Mail - Investors Monthly - - Contents - THABI LEOKA Thabi Leoka is an econ­o­mist at Re­nais­sance Cap­i­tal.

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

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