Markets have largely ignored a good medium-term budget
Last month we saw the budget update on SA’s government finances deliver some very good news, though the market reaction was lost in the sea of negative sentiment prevailing in global financial markets at the time.
The severe ramp-up in market concerns on the global economic outlook since April has seen investors’ risk aversion grow as fears of global recession increased. The persistence of the Russian/Ukraine war and its economic effects, such as sanctions against Russia and higher energy prices, have added to uncertainty for financial markets, as well as for the economic outlook. So too has rapid interest rate hiking cycles and persistently high inflation.
This year has been unique as it provided a fairly lengthy forewarning of a global economic slowdown and then recession. This long lead time caused a substantial amount of risk to be factored in by financial markets, both from the evolving global economic data readings and the relentless focus on higher interest rates.
In this risk-off environment, the fact that 2022’s mediumterm budget policy statement saw lower debt and fiscal deficit (to GDP) projections did not substantially spark foreign investor interest. Instead, foreign investors continued to sell SA government bonds, as has been the case on a net basis since April when consensus expectations on global growth fell.
The resultant rising levels of uncertainty and strong US interest rate hike cycle, as well as the end of all the Covid-19 stimulus, spurred portfolio outflows from emerging markets as foreigners became substantial sellers of these assets.
Consequently, SA’s bond market reaction to the budget was largely muted as the focus remained on global risk events. This is while investors, credit ratings agencies and other keen observers tended towards being sceptical on the projected fiscal consolidation plans. These included gross debt projected to peak at 71.4% of GDP in 2022/2023, more quickly than the previous peak estimate of 75.1% in 2024/2025.
The declining ratios are due to some drop in planned borrowing, as well as a recent revenue overrun, and the National Treasury’s upward revision to GDP forecasts to account for higher inflation.
All these saw debt and fiscal deficit ratios lower as a percentage of GDP going forward. In addition, the 2022/2023 budget deficit is now projected at 4.9% of GDP versus the 6% estimated in February, dropping to 3% in three years’ time — which is seen as fiscally sustainable for an emerging-market economy. The debt projections drop towards 60% of GDP by 2030/2031, with a ratio of 60% or below of GDP seen as sustainable for government finances.
DOWNWARD SPIRAL
A significant degree of planned fiscal consolidation is evident. However, the IMF and Moody’s Investors Service worry about the government’s ability to deliver on the consolidation based on continued pressure for a higher-than-budgeted wage bill, additional relief for stateowned enterprises (SOEs) and further increases in social welfare transfers. Market players are also doubtful.
The downward spiral of sovereign credit ratings for SA, higher expenditure and debt ratios nevertheless have likely been arrested, and positive credit rating outlooks are more likely — with upgrades contingent on fiscal consolidation progressing next year.
The state increased its infrastructure expenditure budget with a strong focus on structural constraints as key impediments to economic growth.
It is unwinding SOE debt guarantees, eliminating its guaranteed debt exposure to SAA. Denel received allocations to pay off its government-guaranteed debt, while selling off noncore assets in a turnaround plan.
The heavy financial dependence of SOEs has lost its lustre and the state is reviewing their value to see “whether they can be run sustainably”. It has developed a draft framework to guide decisions on disposing of and retaining SOEs.
With fiscal consolidation in firm focus, the medium-term budget seeks to reduce fiscal risks while also laying the groundwork to lift economic growth. Both of these areas are heavily affected by the poor financial and operational status of SOEs. The government has said it seeks private sector involvement, the removal of regulatory hurdles and the paring down of the number of SOEs, and that they must become self-funding. But the plan is unwinding slowly.
The Treasury’s job is to provide financial allocations to enable capital expenditure. But it cannot ensure the allocations are spent efficiently and effectively or that they become corruption free.
Furthermore, the increase in remuneration offered to public servants, currently totalling a 7.5% year-on-year rise, is well above the expected 5.6% annual inflation rate next year and still above this year’s expected 6.8%, year on year. This already indicates future pressure on state finances, which cannot rely on better-than-expected revenue collections indefinitely — particularly as Transnet’s and Eskom’s capacities wane.
The medium-term budget operates in severe financing constraints, though it also represents substantial planned progress over a year ago.