Pravin shock puts focus on his midterm budget
Old Mutual analysts say all eyes on whether state spending under control
SOUTH Africa’s medium-term budget policy statement will be delivered on October 26. There was a time when medium-term budget policy statements barely made the news. But with domestic confidence at an all-time low and ratings agencies keeping a careful eye on the country’s finances, all attention will be on whether government spending is under control.
Compounding the pressure on Finance Minister Pravin Gordhan was the announcement this week by the National Prosecuting Authority that he has been charged with fraud.
Are there more surprises in store for beleaguered consumers and will this budget be enough to satisfy the ratings agencies as South Africa fights to avert a downgrade?
Even though the local economy has shown signs of improvement lately with GDP data in the second quarter looking a lot better compared to the first quarter’s negative numbers — meaning we have avoided a technical recession for now — the economy remains in a precarious state.
This is “arguably one of the most significant medium-term budget policy statements ever given the very clear and present danger of a credit ratings downgrade”, said Peter Brooke, manager of the Old Mutual Flexible Fund at Old Mutual Investment Group.
As a result, the markets are much more focused on this budget than they would normally be.
“The actual damage from a downgrade would not be that significant, considering the market has already factored it into its prices, although we would expect a knee-jerk reaction and for the currency to devalue further,” said Brooke. “Of greater concern would be the impact a downgrade would have on investor confidence and savings.”
Gordhan is between a rock and a hard place with a growing demand for spending coupled with a slowdown in the economy, a crisis in tertiary education and political instability. “The slower economy means less revenue growth and subsequently more pressure on the budget,” said Brooke.
Ratings agencies, he said, would be looking at whether the National Treasury had controlled spending. A ratings downgrade would be more likely if it appeared that the Treasury was not doing so sufficiently or was not withstanding government pressure on spending — as it committed to do earlier this year.
“The No 1 priority from the market’s perspective is that the Treasury is adhering to the spending ceiling,” said Brooke.
Johann Els, senior economist at Old Mutual Investment Group, agreed that one of the key requirements in the fight to maintain South Africa’s investment grade credit rating was for the Treasury to keep to the February budget’s fiscal targets.
He predicted that this budget would offer glimmers of hope. “We do think that the Treasury will be able to largely stick to the fiscal targets announced in the February 2016 budget, despite downward pressure on revenue from a somewhat weaker than expected economy.”
In February Gordhan forecast GDP growth of 0.9% this year. Old Mutual Investment Group’s forecast is slightly lower, at 0.5%. Revenue growth for the first five months of the fiscal year is at 7.8% compared with the same period last year — not far off the budget figure of 8.3%. At the same time expenditure is up 6.5% versus the budget target of 6%.
“Both these figures are running relatively close to their targets, but any slippage could mean a slightly higher than budgeted deficit for the full fiscal year of minus R139-billion, or minus 3.2% of GDP,” said Els.
If Gordhan had any intention of overdelivering in terms of the fiscal targets, added Els, then corrective measures, either in the form of further spending cuts or revenue measures, would be needed.
“The medium-term budget is normally not the forum for tax change announcements — but this year might be different,” he warned. “Although tax changes are not easy to implement midway through the fiscal year, Gordhan might decide to announce which type of measures are being considered as a precursor to next February’s budget.”
He said that if further spending cuts were announced it would be a sure sign that the government was serious about overdelivering on its fiscal parameters.
About 60% of consolidated government spending is the wage bill, interest payments on government debt and social grant payments. Recent employment surveys reveal that there is no growth in government employment — in fact, there were job losses in the second quarter, as promised in the February budget. “This will certainly help on the margin,” said Els, adding that the other likely target for cutbacks was capital spending.
He did not expect any reference to be made to the proposed nuclear deal. On the contrary, the expectation was that the Treasury would continue to ignore nuclear spending until more detail was available regarding the cost and possible external funding plans.
South Africa’s underlying growth outlook has started improving, with growth forecasts being revised slightly higher. Els predicted that inflation — which seemed to have peaked in February this year — would head sharply lower in 2017, providing some relief for consumers. “We don’t expect to see any more rate hikes and in fact, we expect rate cuts in the second half of next year.”
Ratings agencies wanted to see that South Africa was serious about implementing growth-friendly economic reforms and, in line with government undertakings to ratings agencies earlier this year, Els said announcements around the national minimum wage, the secret strike ballot, the mining charter and perhaps even state-owned enterprise governance could be expected.
The status of state-owned enterprises was a potential pressure point and would be of significant interest to ratings agencies, said Brooke. “The growing liability of state-owned en-
The actual damage from a downgrade would not be that significant, although we would expect a knee-jerk reaction
terprises is a huge factor as far as the ratings agencies are concerned.”
It was crucial that the government strengthened its pro-growth policies, Els said, as economic growth would make it easier to implement some of the anticipated policy enhancements.
The good news was the fact that the outlook for emerging markets had improved with foreign investors realising that they provided good returns compared to developed economies. Fears of a Chinese recession too are fading as that country stabilises. Commodity prices could stabilise, predicted Els, while emerging market currencies, including the rand, may strengthen. “This all helps overall confidence in the country,” he said.
The risk of a downgrade remains, however, particularly in light of political instability. Old Mutual Investment Group believes the overall economic environment seems to have improved since earlier this year when fears of a recession, runaway inflation, a collapsing rand and sharply higher interest rates prevailed.
“Treasury will do everything in their power to direct the budget towards a position where it can avert a downgrade,” said Els. “We get the sense that the somewhat better than expected economy and outlook has reduced the risks of a downgrade a little. However, the continued uncertainty around the minister of finance’s political future puts these tentative signs of progress at risk.”
What this budget would reveal was whether the Treasury and the minister of finance remained in control of the state’s coffers. “National Treasury is crucially important to the institutional stability of South Africa and the medium-term budget policy statement has long been seen as a mark of excellence,” said Brooke. “Any threat to this credibility has long-term economic risks. The real battle now is not with ratings agencies but rather to grow confidence in the country. This will encourage investment which will drive growth.”
Although more growth is expected in 2017, whether this will be enough for the ratings agencies remains to be seen.