Why the market greeted Tito’s October budget with no surprise

So the finance minister tables an October budget with an even worse debt trajectory than his June budget and an even higher risk that plans to stabilise the debt will be derailed by labour. Yet, far from fleeing in horror, investors greet it with equanimity. This week’s budget now sees the debt stabilising at 95% over a five-year time frame compared to the 87% over three years in June’s active scenario. And though the total in cost cuts required to get there is less over-ambitious than in June, it depends a lot more heavily on steep cuts to the wage bill over the next three years. If the current year is included, the Treasury is now targeting R460bn of savings over a four-year period, R310bn of it from a public sector wage freeze.

With tough public sector wage negotiations due to start only next year, hardly anyone is convinced those cuts will be achieved. Nor does the government have a fabulous track record of delivering on the fiscal consolidation it has promised year after year. So why are the bond market investors on whom it depends to fund the deficit still so tolerant? And what does it look like if or when that ends?

The first, simple answer is money. SA now offers the highest real yields of any emerging market, with an inflation-adjusted yield of almost 6% on its 10-year bonds. That reflects investors’ concerns about SA’s economic growth trajectories — as does the fact that foreign investors aren’t piling into our bonds as they used to even with these yields.

The flipside of the high yields is that the government is borrowing on the bond market at very high cost. It’s now spending 21c in every rand it collects in tax revenue just to pay interest to bondholders — and that’s set to rise further as government debt heads up to R5-trillion, as this week’s budget indicates it will by 2022-23, even with the cuts.

Another answer is that investors weren’t convinced by June’s budget anyway, so this week’s is at least seen as more realistic. And uncertainty about whether the wage cuts can be delivered is no more than it was in June — or will be in February, when the main budget is tabled. For now, uncertainty is priced in — but certainty could shift sentiment suddenly, and potentially dangerously.

Yet another, crucial answer is that market conditions have been favourable. At home, banks have been big buyers of the bonds that foreign investors have sold — though that will surely change as the economy recovers and there’s less saving and more appetite for credit and investment. Internationally, the ultra loose monetary policies of advanced nations in the Covid crisis have driven interest rates to zero and flooded markets with liquidity, which has to go somewhere.

But that won’t last forever. The danger is international financial conditions could turn quite suddenly when the US Federal Reserve and its peers signal they are ready to start normalising monetary conditions again — as they may well do 18 to 24 months from now. That gives SA only a narrow window in which to get its fiscal house in order. It could run into trouble even sooner if the economic recovery or the wage talks stall or any number of other fiscal risks materialise.

The budget numbers showjust how vulnerable SA’s public finances are to anything that would trigger investors to turn suddenly intolerant. That would drive up the cost of borrowing even further — or, in the extreme, shut off the government’s access to markets so that it could not borrow the cash it needed, forcing it to choose between paying the interest on its debt and paying social grants or salaries.

That’s what a debt crisis would look like. It would have a domino effect across the entire financial system and would result in a deep recession. SA cannot afford to get even close to that scenario.

No wonder finance minister Tito Mboweni this week warned loudly and repeatedly of the risk of a debt crisis — and of the need to act now to avoid it.

SA has only a narrow window in which to get its house in order