CLOSER TO THE BRINK

With huge revenue shortfalls looming, government will have to take sustained corrective action in the wake of yet another downgrade, more job losses and plummeting business confidence

This time last year, when Pravin Gordhan and business leaders presented a united front to the rating agencies, SA was spared a single downgrade. This year, with the compromised Malusi Gigaba at the helm, the country has been downgraded by all three.

Last Friday it was Moody’s turn. It cut

SA’S sovereign ratings by one notch, putting both the foreign- and local-currency ratings on the cusp of junk, one notch above Fitch, which junked all SA’S ratings in April.

SA has a split rating with S&P. It junked SA’S foreign-currency rating in April but the local-currency rating remains investment grade.

Moody’s downgrade puts SA’S ratings with the agency right back where they started in 1995 at the dawn of democracy, 22 years of progress having been wiped out.

Moody’s view is that recent political developments have significantly weakened SA’S economic and institutional strength and governance. This casts doubt over whether growth can be restored and debt stabilised any time soon.

It also retained its “negative” outlook on SA’S ratings. This means that unless there are signs of stabilisation and recovery in the next six to 12 months, another downgrade is likely.

The tone of Moody’s statement was more bearish than expected. Though it didn’t junk SA’S ratings (which would have required it to cut by two notches), its scepticism over SA’S reform prospects is significant because for many years Moody’s had given the country the benefit of the doubt.

In May 1995, Moody’s awarded SA, under the new ANC government, an investmentgrade rating at a time when S&P and Fitch considered SA to be a speculative bet.

Moody’s faith in SA was vindicated as growth rebounded and debt was shed over the following decade. Moody’s led the other rating agencies on the way up, hiking SA’S ratings consistently to peak at A3, four notches above junk status, in June 2009. However, since 2012, Moody’s has downgraded SA three times, following the path laid by S&P and Fitch, which have led on the way down.

As long as Gordhan was finance minister and had the support of business, Moody’s held out hope that he would galvanise the structural reforms needed to lift the growth rate.

Few domestic analysts had much convic-

What it means: Moody’s loses faith in SA; huge revenue shortfall predicted and business confidence collapses

tion, for, though the efforts of Gordhan and the CEO Initiative were genuine and delivered some useful projects, the minister’s attempts at deeper reform were frustrated at every turn.

In March he was dismissed by President Jacob Zuma and replaced with Gigaba in a midnight cabinet reshuffle. The move resulted in S&P and Fitch immediately junking the country’s credit ratings — and this was before Gigaba had been implicated in appointing people with Gupta links to the patronage boards of state-owned enterprises (SEOS).

So now when Gigaba promises to “safeguard confidence and reclaim the investment grade ratings”, “speed up” work with the social partners and “fast-track” structural reforms to raise economic growth, his words lack any credibility. How can he of all people be taken seriously when he promises to reform SOES which, as a result of poor corporate governance and procurement policies, now pose the biggest risk to the fiscus?

Last week, Moody’s finally changed its tone. Explaining why it had retained a “negative” outlook on SA’S ratings, it said: “It is unlikely that a political consensus will emerge which supports investment in the economy and reinvigorates the reform effort sufficiently quickly to reverse the expected negative impact on growth and on government’s balance sheet.

“The opposite scenario, of heightened political dysfunction, continued gradual institutional weakening and diminished clarity over policy objectives, has a higher likelihood.”

This means that unless government is able to encourage private investment, which leads to higher economic growth and an improvement in government finances, Moody’s will be forced to junk SA, explains Stanlib chief economist Kevin Lings.

The country was still reeling from the news that the economy had slid into a recession, that unemployment had hit a new high of 27.7%, and that all three rating agencies had downgraded it when another shocking piece of news was delivered this week — business confidence has completely collapsed.

The Bureau for Economic Research/rand Merchant Bank (RMB) Business Confidence Index (BCI) plunged by 11 points to 29 in the second quarter — a level last seen during the deep economic recession of 2009. “Deeply concerning is that not a single sector now has a reading above 50,” says Ettienne le Roux, RMB’S chief economist. “This is rare!”

Confidence among manufacturers fell to 16 (from 28), among retailers to 35 (from 45), building contractors to 36 (from 42), wholesalers to 49 (from 56) and new-vehicle dealers to 11 (from 30).

This is the first BCI reading that reflects the effect of the cabinet reshuffle and ratings downgrades on business sentiment. “But the drop reflects more than just the impact on sentiment of greater political uncertainty,” says Le Roux.

“Many of our respondents are genuinely worried about how weak underlying activity is in their respective industries.”

For instance, eight out of every 10 respondents in manufacturing are complaining that insufficient demand is constraining their business. This is close to the highest reading on record.

“Confidence is the real problem,” says Le Roux. “Corporates don’t lack the ability and means to invest but the confidence. Almost without exception the corporates we’re speaking to are adopting a wait-and-see attitude.”

Confidence is being held hostage to the electoral cycle. Unless Zuma and his corrupt project are swept aside at the ANC’S December conference where a reforming ANC president emerges victorious, there is unlikely to be a recovery in confidence.

“There is no worse combination than a recession and bad politics because it makes your economy so vulnerable,” says Le Roux, “It always starts and ends with the public finances because that’s where the cracks show up.”

Gigaba must deliver a medium-term budget in October. Now that economic growth is rapidly shrinking back towards the 2016 growth rate of 0.3%, government is likely to experience a huge revenue shortfall.

Just to stick to Gordhan’s fiscal consolidation path, which had assumed growth of 1.3% in 2017 and 2% in 2018, was going to require an additional R43bn in revenue and a R52bn cut to the spending ceiling over the next two fiscal years.

If growth comes in at half of treasury’s estimates, but tax buoyancy recovers to above one and inflation averages 6% (both generous assumptions), an additional R40bn will be needed over that period, estimates RMB.

A one percentage point hike in Vat would deliver R20bn in extra revenue. It would be the least economically damaging means of raising revenue but, because of the impact on the poor, it would be political suicide for the ANC in the run-up to the 2019 election. Government was also keeping a Vat hike in reserve to fund National Health Insurance.

Taxing the rich more seems inevitable but is unlikely to yield much, given how few people reside in the highest tax brackets. For instance, the increase in the maximum marginal income tax rate to 45% on incomes over R1.5m is expected to raise just R4.3bn this fiscal year.

In any event, the latest GDP data shows there will be a large negative impact on growth if taxes are raised further. Cutting public expenditure too ruthlessly could also be self-defeating for the same reason. This means that to prevent a blow-out in the public finances, Gigaba has little option but to restore business confidence.

Restoring confidence would also be the cheapest way of restoring growth because it wouldn’t cost a cent, but it would require leadership that understands that SA is in danger of losing its grip on fiscal sustainability.

Gigaba took a good first step last week by appointing the solid treasury technocrat Dondo Mogajane as his director-general, but only sustained corrective action will convince business to invest.

Investec Asset Management’s Nazmeera Moola says SA also needs the appointment of a sound chief procurement officer in treasury, the release of a mining charter that does not harm mining companies, the signing of outstanding independent power producer contracts, and progress on digital migration.

There is no escaping the conclusion that government has to change tack decisively in the way it is running the country. If it is incapable of doing what is necessary to win back business confidence it runs the risk of dooming the economy to further credit-rating downgrades and growth disappointments in a downward spiral.

It is that harsh and that simple.

It is unlikely that a political consensus will emerge which supports investment in the economy and reinvigorates the reform effort sufficiently quickly to reverse the expected negative impact on growth and on government’s balance sheet Moody’s