FED’s HOLD WELCOME RELIEF
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.