Doomsday scenarios all too credible if we don’t act fast
Anyone who thinks the “R” word is a thing of the past might want to look at the scenarios for the economy sketched in last week’s Budget Review. The worst-case scenario has SA in recession for the next two years, with budgetary woes and an inability to address Eskom’s financial and operational crises causing a fiscal crisis and a ratings downgrade. The next-worst scenario is hardly better — near-zero economic growth as Eskom loadshedding stretches out over 18 months and exports decline. Bleak as they are, these are not outlandish scenarios — they seem distinctly possible if the government cannot act fast (18 months of load-shedding is what happened in 2014/2015, for example). And the risk is that if they materialise, government finances could end up in even worse shape than last week’s budget numbers forecast. On the upside, the best-case scenario has the economy growing at just over 2% this year, rising to just under 3% in two years’ time, as “short-term reforms outlined in the 2018 budget are implemented quickly and effectively, and long-term reforms that reduce barriers to entry begin to take shape”. So not impossible, even if 2% to 3% is not quite the unemployment-busting 5% SA once aspired to.
In publishing the four scenarios — the first time the Treasury has included this many — the objective is to highlight the downside risks to growth and therefore to its own budget and revenue numbers, putting these front and centre. But, after six or seven years in which the
Treasury’s economic growth forecasts have fallen consistently short of budget forecasts, rating agencies and investors ask the Treasury all the time about what growth and macroeconomic assumptions it has made in crafting the budget. The scenarios respond to that, building the credibility of the budget numbers, but making it amply evident, also, just how big are the uncertainties looming over the budget framework.
The budget documents don’t spell out the fiscal consequences of the economic scenarios, but the budget-busting effects of the adverse ones would if anything be worse — and the warnings on how out of control the public debt could get if things go horribly wrong must be heeded.
Interestingly, the preoccupation in October’s medium-term budget policy statement was more with global events. Now, front and centre is the twofold risk posed by Eskom — its financial crisis and the impact that could have on the public purse and on SA’s credit ratings, and its operational crisis and the risk that prolonged load-shedding poses for growth, confidence and exports.
The other big set of risks is around ratings and what that could mean for SA’s sovereign risk premium — how much extra risk investors see in investing in SA and how much return they therefore demand to put their money here. That affects the cost of capital and therefore interest rates and growth. The Treasury estimates a Moody’s downgrade would drive up the sovereign risk premium by 210 basis points, with bond yields rising by 180 basis points, and that would raise interest rates and undermine investment and growth.
Moody’s is due to visit SA this week, and its decision, which is due at the end of March, is, by all accounts, still finely balanced. The Treasury’s worst-case scenario takes an ultra-conservative view of the impact of a downgrade; others are less pessimistic.
The dilemma in crafting the budget is always how conservative a scenario to choose as a baseline — too optimistic and you risk committing the government to spending that it ends up being unable to afford; too pessimistic and you risk a self-fulfilling prophecy in which a tight budget itself exacerbates growth woes. If nothing else, the scenarios serve to underline how uncertain the outlook is and how difficult the balancing act involved in the budget numbers.
It’s evident just how big are the uncertainties looming over the budget