SA set for a cliff-hanger
BUDGET: WILL MBOWENI BE ABLE TO SAVE SA FROM A MOODY’S DOWNGRADE?
With pressure points aplenty and only a few upsides, the country is keen to know what the plan is.
Finance Minister Tito Mboweni’s medium-term budget presentation today will most certainly be a cliff-hanger. The landscape is precarious, but the country is not yet in freefall, as the following key factors indicate.
National Treasury has previously suggested that it expects a progression of gross loan debt to a high of over 60% of GDP by 2023. This implies even higher costs of servicing debt over time. An upward revision in government’s debt levels without the necessary policy initiatives to address them will not impress credit rating agencies or potential investors.
Guarantees to state-owned enterprises (SOEs) stand at more than R520 billion. Drastic measures must be taken to restructure these entities – including selling off unproductive assets in some cases.
Some market analysts have suggested that the economy would need to grow at more than 2.5% per annum in order to balance the budget over five years. Our declining potential growth numbers suggest that this is not likely to happen. Growth in 2019 is expected to be about 0.6%.
A risk for all developing economies is market volatility emanating from uncertainty over the US-Sino trade dispute. One might expect borrowing costs and currency volatility to rise as tensions increase, reducing the ability for developing countries to service their debt.
This issue is even more acute due to South Africa’s reliance on external funding.
So far, Fitch and S&P have downgraded the South African sovereign to junk while Moody’s rates the country one notch above sub-investment grade.
Moody’s recently stated that the country’s stable outlook provides a low probability that the country’s credit rating could change. It has avoided downgrading South Africa because it expects the country’s debt to stabilise.
Consider the recent successful issue of the $5 billion Eurobond. Such support may be expected to continue while yields in much of the developed world remain comparatively low.
An IMF bailout might be required if:
There are multiple sovereign downgrades deeper into sub-investment grade territory;
Flight of capital from the country accelerates; and
SA is unable to borrow at reasonable rates.
South Africa’s issuance of hard currency debt is a relatively small proportion of overall debt (about 10% at the last budget presentation).
A higher proportion of hard currency debt is initially positive for the central bank’s foreign reserve balance. However, in the long run it increases the risk of being unable to manage the country’s balance of payments in a distress scenario.
The country’s floating exchange rate regime and healthy level of foreign currency reserves also help in managing the balance of payments.
Most of South Africa’s borrowing has been in the form of long-dated bonds, which buys some time to manage the fiscal situation gradually. Many countries requesting a bailout do so because they have debt maturing that they cannot roll over.
A potential red flag in future is National Treasury’s suggestion of increased issuance of shorter-term Treasury bills rather than long-dated debt.
Grace Debeila is a portfolio manager at Mergence Investment Managers