FED’s HOLD WELCOME RE­LIEF

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The mini-bud­get on Oc­to­ber 21 will take cen­tre stage on SA’s eco­nomic cal­en­dar this month. It will be closely watched by an­a­lysts and rat­ing agen­cies for signs of fur­ther fis­cal slip­page in an ex­tremely test­ing eco­nomic en­vi­ron­ment.

At best, SA faces sev­eral years of eco­nomic stag­na­tion caused by its fail­ure to over­come do­mes­tic labour, in­fras­truc­tural and energy con­straints. At worst, it may dip into a re­ces­sion amid a global eco­nomic slow­down and col­lapse in com­mod­ity prices.

“With 30%-40% of GDP al­ready con­tract­ing, it wouldn’t take much of a blow to push the econ­omy over the edge,” says Rand Mer­chant Bank chief economist Et­ti­enne le Roux. “On­go­ing labour mar­ket gy­ra­tions in the gold min­ing sec­tor re­main wor­ry­ing. We can ill af­ford another pro­tracted strike and the mul­ti­plier ef­fects as­so­ci­ated with it.”

Against this back­drop, fi­nance min­is­ter Nh­lanhla Nene has been dealt a very bad hand: at a time of slow­ing growth and ris­ing global risks, the SA gov­ern­ment has struck a public sec­tor wage deal that will wipe out the con­tin­gency re­serve, put the ex­pen­di­ture ceil­ing un­der pres­sure and limit the fund­ing for any new poli­cies.

In short, it re­moves the last bit of fis­cal wig­gle room at a time when fis­cal shocks could be trans­mit­ted by the start of rate hikes by the US Fed­eral Re­serve (Fed), which some fear could trig­ger a rand cri­sis.

At the time of writ­ing, the Fed had just de­cided to keep rates un­changed at its Septem­ber meet­ing, cit­ing the weak global econ­omy, fi­nan­cial mar­ket tur­moil and low­ered in­fla­tion out­look.

The de­ci­sion, com­bined with the Fed’s dovish change in fore­casts and state­ment, was pos­i­tive for the rand, which ini­tially strength­ened from R14,01 to R13,17/$ be­fore pulling back slightly.

How­ever, RMB cur­rency strate­gist John Cairns says one con­se­quence of not hik­ing is that the rand will likely re­main plagued by volatil­ity be­cause of the re­newed un­cer­tainty as to when the hike will come: Oc­to­ber, De­cem­ber or per­haps in 2016.

Four Fed of­fi­cials out of 17 voted to de­lay the lift-off to next year while 13 forecast at least one hike this year.

Fed fu­tures are pric­ing in only a 16% chance that the move will be at the Fed’s in­terim meet­ing in Oc­to­ber but a 40% chance of a hike in De­cem­ber.

That will be another red let­ter day for the rand.

Turn­ing back to the mini-bud­get, the first fig­ure most econ­o­mists will look for will be the ex­tent to which Nene re­vises down the na­tional trea­sury’s growth forecast.

In Fe­bru­ary this year, it bud­geted for real GDP growth to av­er­age 2,0% over the course of the year, ris­ing to 2,4% in 2016 and 3,0% by 2017. This ex­pec­ta­tion of a fairly steep re­cov­ery has, how­ever, been dashed with each pass­ing month as SA’s eco­nomic data has con­tin­ued to de­te­ri­o­rate.

The most wor­ry­ing fig­ure re­leased last month was the fall in the RMB/BER Busi­ness Con­fi­dence In­dex (BCI) from 43 to 38 in­dex points in the third quar­ter, its low­est since the fourth quar­ter of 2011.

The BCI is closely linked to pri­vate sec­tor fixed in­vest­ment. The con­sec­u­tive sharp down­turns in busi­ness con­fi­dence in the sec­ond and third quar­ters bodes ill for the econ­omy’s growth and job-cre­ation prospects, given that

The re­al­ity is, only un­pop­u­lar fis­cal de­ci­sions will safe­guard the coun­try’s sov­er­eign in­vest­ment credit rat­ing

pri­vate fixed in­vest­ment growth is al­ready con­tract­ing year on year.

The Reuters con­sen­sus has de­clined in tan­dem. Most econ­o­mists now ex­pect growth to av­er­age just 1,9% this year, climb­ing to 2,1% in 2016 and 2,5% by 2017.

This im­plies a short­fall in gov­ern­ment rev­enue and hence fat­ter fis­cal deficits in each of the next three fis­cal years than the sharp con­sol­i­da­tion of 3,9%, 2,6% and 2,5% of GDP bud­geted for. That is, un­less Nene cuts spend­ing out­right or raises taxes, or both.

SA’s abil­ity to stick to this fis­cal con­sol­i­da­tion path is one of the most im­por­tant in­di­ca­tors used by rat­ing agen­cies to judge whether the coun­try is se­ri­ous about stop­ping the ero­sion of its public fi­nances.

“Given the jam the min­is­ter is in, will tax rates go up again and/or will the min­is­ter now ac­tu­ally cut cer­tain spend­ing bud­gets out­right to en­sure ini­tial bud­get deficit tar­gets are met?” asks Le Roux. “The re­al­ity is, only un­pop­u­lar fis­cal de­ci­sions will safe­guard the coun­try’s sov­er­eign in­vest­ment credit rat­ing.”

Trea­sury has made no bones about the fact that SA’s public fi­nances are strain­ing the lim­its of debt sus­tain­abil­ity but, given the need to sup­port growth, it has so far avoided out­right spend­ing cuts. In­stead it has slowed ex­pen­di­ture growth in line with a set ceil­ing.

But given SA’s dis­ap­point­ing growth per­for­mance and over-bud­get public wage agree­ment this year, stick­ing to a spend­ing ceil­ing may no longer be suf­fi­cient to bal­ance the books.

The dan­ger is that in mak­ing spend­ing cuts, gov­ern­ment will cut cap­i­tal bud­gets rather than con­sump­tion spend­ing. Econ­o­mists will be watch­ing the mini-bud­get closely to make sure that growth-en­hanc­ing in­fra­struc­ture spend­ing is pro­tected.

In ad­di­tion to spend­ing cuts, the mini-bud­get could also sig­nal that SA will face another round of tax in­creases in 2016 as gov­ern­ment tries to nar­row the gap be­tween rev­enue and ex­pen­di­ture.

If Nene does sig­nal tax in­creases, the most eco­nom­i­cally ef­fi­cient can­di­date would be to hike the 14% Vat rate.

Ear­lier this year, the Davis Tax Com­mit­tee rec­om­mended that if gov­ern­ment needed to raise taxes, it should raise Vat rather than per­sonal or com­pany taxes since the neg­a­tive im­pact on real GDP and em­ploy­ment would be far less se­vere for a Vat in­crease than for ei­ther of the other two taxes.

How­ever, in an in­ter­view with the Fi­nan­cial Mail last month, Nene ap­peared to rule out a Vat in­crease, say­ing: “Though you can­not close the door com­pletely on any form of rev­enue rais­ing with­out a com­pelling rea­son, the fact is that Vat is a re­gres­sive tax and the econ­omy is not do­ing well at the mo­ment, so it is in­ap­pro­pri­ate.”

That may be, but Nene can­not es­cape the fact that the only two op­tions open to him — to raise taxes and/or cut spend­ing — will both be un­pop­u­lar and un­palat­able. But act he must.

“With eco­nomic growth con­tin­u­ing to slow, the bud­get deficit still wide . . . and no sign that the pol­icy tra­jec­tory will shift any time soon, SA re­mains on a firm path to­wards fur­ther down­grades over the com­ing months and quar­ters,” warns Bid­vest Bank in a re­search note.

Re­cent com­ments from Fitch and Stan­dard & Poor’s (S&P) note that the news flow on SA has largely been neg­a­tive since their pre­vi­ous rat­ings an­nounce­ments.

On bal­ance, the risk of fur­ther down­grades is in­creas­ing but bar some calamity, SA is un­likely to be down­graded to junk sta­tus as early as this year.

Both Fitch and S&P are sched­uled to an­nounce rat­ings de­ci­sions on De­cem­ber 4. Even though Nene is likely to de­liver a cred­i­ble mini-bud­get, it can­not dou­ble as a growth strat­egy. There is just no more room to use the fis­cus to stim­u­late growth.

There­fore Fitch is fairly likely to fol­low S&P’s lead by cut­ting SA’s sov­er­eign rat­ing by one notch in De­cem­ber from BBB to BBB-, which would place SA on the last rung of the in­vest­ment grade rat­ings lad­der. S&P is likely to change the out­look on its BBBsovereign rat­ing of SA from sta­ble to neg­a­tive, leav­ing SA just a whisker above junk sta­tus.

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