GIGABA MUST CROSS CHASM IN OCTOBER
In October, nothing will absorb the financial community’s attention more than the medium-term budget review. The “mini-budget” will be finance minister Malusi Gigaba’s first budget and the most challenging since the global financial crisis.
The stakes are high: SA is at risk of getting trapped in a protracted period of weak growth which would worsen fiscal pressures and could land it in debt distress within five years.
For the fifth year in a row, treasury has overestimated annual GDP growth. In February it projected that growth would recover to 1.3% this year on the back of better global trade, higher commodity prices and a rebound in agriculture.
Instead, President Jacob Zuma ousted finance minister Pravin Gordhan, SA’s credit ratings were immediately junked and the economy was plunged into a recession. SA will now be lucky to grow by half of treasury’s estimate this year.
The upshot is that at the medium-term budget on October 25, Gigaba is expected to project a revenue shortfall of a staggering R44bn — R50bn for the current fiscal year, up from R30bn last year.
The situation would be less serious if 2017 was just a single, bad year or if there was a clear prospect that SA could grow its way out of trouble. There isn’t.
SA’s public finances have been deteriorating steadily for several years, mainly because of excessive spending on a bloated government in a climate of disappointing growth.
Since the global financial cri- sis, the budget deficit has failed to shrink below 3% of GDP and the interest bill has climbed steeply. It is expected to reach almost R200bn by 2019-2020 from R146bn last year.
Gigaba’s options are limited. Though substantial tax hikes or expenditure cuts would help to balance the books they would detract from growth, which could be self-defeating.
But allowing further fiscal slippage and straying from the fiscal consolidation path laid down by Gordhan would arguably be worse. Confidence would be further shaken and all SA’s credit ratings would probably be junked.
SA’s local currency debt is still investment-grade with S&P and Moody’s, though the outlook is “negative” with both. Sitting on the cusp of junk, it wouldn’t take much to tip all SA’s ratings over the edge.
If this happened, SA would be automatically ejected from the World Government Bond Index, forcing many large investment funds to divest their SA government bond holdings. This could result in capital outflows of up to R150bn.
A full-blown rand crisis and deep recession, from which it could take many years to recover, could then develop.
To avoid this, Gigaba is likely to signal that the next three years will require broad-based tax hikes; expenditure cuts across all departments; a lowering of the expenditure ceiling; and a big emphasis on rooting out wastage and corruption.
Expect him to issue a stern rebuke to the recalcitrant stateowned enterprise (SOE) sector as well as a possible warning that, should growth not recov-
The EFF and Cosatu have reacted furiously to reports that there is a plan to direct the PIC to use workers’ retirement funds to bail out SOEs
er, a Vat hike of 1%-2% could become unavoidable.
Argon Asset Management economist Thabi Leoka says that given poor growth and rising poverty and unemployment, it’s unlikely there will be a Vat increase.
But she thinks an increase in personal income tax is likely in February 2018.
On the revenue side, Nedbank Corporate & Investment Bank research analyst Reezwana Sumad expects a significant drawdown from the contingency reserve over the next three years as well as the removal of the medical aid tax credit, which would bring in a further R20bn/year.
On the expenditure side, she expects National Health Insurance (NHI) to be deferred, the public sector wage bill to be lopped by R1.5bn, a further R30bn in savings from procurement reform, R27bn from tackling corruption, and R46bn from reducing wasteful and unauthorised expenditure, among other things.
But even if Gigaba manages to make the numbers hang together, it will not be enough. He has to have a convincing plan to restore growth.
In July, he reassured SA that he did indeed have such a plan. It lists more than 45 administrative and regulatory actions that government is committed to taking. While all these undertakings — including the recent appointment of a promising new CEO for SAA — are welcome, they fall short of the kind of structural reform that could shift the needle on growth, certainly not in time to save 2017 from being a bust.
To catalyse growth will require boosting skills and productivity; hiking the investment rate to upwards of 25% compared to around 19% now; slashing transport and communication costs; and increasing competition between firms.
To realise even one of these reforms will require a capable state united behind an inspiring leader. Unfortunately, the economy remains stuck in limbo until the ANC elective conference in December.
Can there be anyone in SA who believes that if Zuma or his proxy wins the December vote they will retrench civil servants, delay NHI, slash spending, and hike Vat in the run-up to the 2019 general election, even though this is exactly what is needed to shore up the country’s fiscal sustainability?
So even if Gigaba promises these necessary reforms, his gameplan will lack credibility until it is backed by political intent.
The way the budget treats SOE bail-outs will be particularly instructive.
The market is waiting to see where Gigaba plans to find the R10bn requested by SA Airways, given that treasury has previously said any support for SOEs must be deficit-neutral.
The most likely options are the sale of noncore assets (government’s Telkom shares) or that the Public Investment Corp (PIC) will be instructed to lend the funds or make a direct equity injection into the airline.
The EFF and Cosatu have reacted furiously to reports that there is a plan to direct the PIC to use workers’ retirement funds to bail out SOEs, and indeed, that there is a plan to replace the PIC’s chief executive Dan Matjila with a more compliant person who will enable this.
The danger, says Sumad, is that an SAA bail-out may signal to other financially stressed SOEs that government remains tolerant of unconditional bailouts. “This may be the start of a series of bail-outs if no SOE reform is implemented and if treasury does not take a hard stance against failing SOEs.”
The big worry is Eskom, which has become “too big to fail”. Guarantees to Eskom total R350bn — nearly two-thirds of total SOE guarantees and 8% of GDP. Of this, Eskom has already drawn down R218bn.
Investor activism against Eskom’s appalling lack of governance has curtailed its ability to raise funds on the local market and increased the likelihood that it will require direct budgetary support.
On the global front, the most important event next month will be the meeting of the European Central Bank (ECB) on October 26. The market is widely expecting it to announce when it will begin tapering off its quantitative easing programme and at what pace.
Rand Merchant Bank chief economist Ettienne le Roux says that though the move will not necessarily lead to another taper tantrum, it could reduce support for the rand, given that the recent risk-on environment has been fuelled by ample global liquidity.
“If the Fed and the ECB are both tapering it could undermine the rand, especially if it coincides with continued slower growth in China and lower commodity prices,” he says. “That would be a bad cocktail for emerging markets, which have been the flavour of the month.”