GI­GABA MUST CROSS CHASM IN OC­TO­BER

Financial Mail - Investors Monthly - - Opening Bell - with Claire Bis­seker

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.”

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