Swift action with Eskom will help Moody’s to decide
After finance minister Tito Mboweni’s maiden budget speech last week, economists and analysts are split on whether SA will avoid a new credit ratings downgrade to subinvestment grade by Moody’s when it issues its review on March 29. Those who believe Moody’s will downgrade SA’s last remaining investment grade rating cite the deterioration in the fiscal position. I believe Moody’s will neither change the stable outlook nor downgrade.
Total government debt stabilises at 60% of GDP seven years later than expected in 2023/2024, while the consolidated fiscal deficit widens to 4.5% of GDP in fiscal 2019/2020 before narrowing to 4% in 2021/2022. This represents less than one percentage point of GDP in fiscal slippage. The breach of the expenditure ceiling is a concern, but we already know Moody’s view on that — it is unlikely to weaken fiscal policy credibility given increased fiscal transparency and the long track record of adherence to the fiscal framework.
In simple terms, there is fiscal slippage because institutions have been weakened, and as a result investment and economic growth have been moderating, leading to lower tax revenues. Expenditure has continued to rise in real terms despite declining tax revenues. It is therefore plausible to say rebuilding institutions should be the important preoccupation that will reinvigorate growth.
Let’s square up the decimal points fiscal slippage with the long list of reforms under way: the restructuring of Eskom and the electricity sector in general; the coming rationalisation of government departments that have already started with budgeted plans to reduce the public sector wage bill by R27bn; strengthening our law enforcement with the appointment of the national director of public prosecutions; re-establishing the priority investigative unit in the National Prosecuting Authority; boosting the SA Revenue Service; giving new teeth to the auditor-general and Competition Commission; and in all likelihood a sensible resolution of land reform — all point to rebuilding institutions that have weakened SA’s potential economic growth.
Based on this I believe the decimal points deterioration in the country’s fiscal metrics are outweighed by the structural reforms under way. The government must just finalise its plan for restructuring Eskom before the rating action and open the books for all to see the details. If these are credible, Moody’s will be likely to save the country’s credit rating from going junk.
If the details of the Eskom restructuring leave too many questions unanswered, it’s likely that Moody’s will change the outlook to negative from stable or, worse, put the rating on review for a downgrade. A change to negative outlook is typically resolved in 18 months, while a review for a downgrade is usually resolved in three months. Either way, this buys the government time to put together a credible plan.
This elevates the importance of the October 2019 medium term budget policy statement. By then we will have a new, smaller cabinet, and a decent time frame to compare announced reforms with what actually gets implemented.
If implementation after the elections follows historical trends, a credit rating downgrade will be almost certain.
Although economists and analysts are split on the likelihood of the downgrade, bond and currency markets already price in a downgrade. SA’s currency and bond yields trade weaker relative to similarly rated countries. The price for buying insurance for holding the five-year US dollardenominated SA bond — CDS spreads — is higher than that of Brazil, which is already subinvestment grade. This implies that even in the event of a downgrade to subinvestment grade the effect is likely to be less pronounced than initial estimates in 2018 this time.
Estimates of the impact on SA bond markets vary. At the extreme, bond yields are likely to go up by about 100 basis points and the currency depreciates by anywhere between 10% and 20% over a short period. However, looking at more than 20 years of historical data of countries that have been downgraded to subinvestment grade, both bonds and currency markets improve 12 months after the downgrade. However, regaining investment grade takes on average an excruciating seven years, which is why it must be all hands on deck for SA Inc to avoid the credit ratings downgrade.
● Mhlanga is executive chief economist at Alexander Forbes.