MTBPS - Limited options need political will to execute
Economic growth and inflation rates revised significantly lower.
Tax revenue collection shortfall of R52bn in 2019/2020.
Debt to GDP ratio rises above 70% over the medium term and continues to rise thereafter.
Moody’s will likely change the outlook from stable to negative on 1 November followed by a downgrade in 2020 if no reforms are implemented.
Bond yields will likely rise and the rand will weaken against the US dollar although it appears that the negative rating action is largely priced in already.
Fiscal unsustainability to trigger negative rating action and market sell-off
The Medium Term Budget Policy Statement (MTBPS) highlights the unsustainability of the debt trajectory and shows that it has worsened significantly. Even after removing the impact of Eskom’s bailouts, the debt trajectory still remains unsustainable in the medium and long term. The fiscal outcomes are worse than expected and are due to downward revisions in economic growth, tax revenue collections, more bailout provisions for Eskom, and other state-owned enterprises (SOEs) bailouts while expenditure cuts remain on the margin. The fiscal challenges extend beyond Eskom and will require political will to resolve.
Economic outlook has deteriorated as expected
The MTBPS has revised the economic growth forecast to 0.5% in 2019, gradually rising to 1.2%, 1.6% and 1.7% in 2020, 2021 and 2022 respectively. These forecasts are significantly lower than those presented in the February Budget Review, which were1.5%, 1.7% and 2.1% in 2019, 2020 and 2021 respectively.
The 2019 budget assumed an inflation growth of 5.2% for 2019, and 5.4% for 2020 and 2021. The inflation forecast has been downwardly revised to an average of 4.3%, 4.9% and 4.9% for 2019, 2020 and 2021 respectively, all of which are lower than the budget assumptions. The lower inflation expectations imply that nominal GDP growth will be lower than budgeted.
The budget assumed a tax buoyancy rate of 1.31 in 2019, followed by 1.17 and 1.08 in 2020 and 2021. However, for the past three fiscal years, tax buoyancy has averaged 0.96. Tax buoyancy rates were overestimated, especially in an environment of weak economic growth, high unemployment and declining corporate profitability. SARS warned us a few weeks ago that there is a high probability that tax collections will disappoint relative to the budget. In line with this, tax buoyancy rates have been reduced to approximately 1.0.
Fiscal trajectory unsustainable with or without Eskom financing included
As a result of the three factors, there will be a sizeable revenue shortfall of R52.2bn in the current fiscal year, R84bn in 2020/20/21 and R114.7bn shortfall in 2021/2022. The fiscal deficit rises from an initial budget of 4.5% to 6.2% in the current fiscal year, up to 6.8% in 2020/2021. The debt to GDP ratio rises to 60% in 2019/2020 from an estimate of 57% in the budget. The debt trajectory rises to 68% of GDP without including the Eskom financing in 2022/2023. If the Eskom financing is included, it rises to 71.3%. In both these scenarios, debt to GDP ratio rises above 75% in the next decade.
This is the problem: the debt trajectory is not stabilising, even at a 3% growth rate, implying that the fiscal problems extend beyond Eskom. The onus is now on the government, labour and civil society to implement the economic reforms that are required to lift economic growth and to reduce the fiscal burden caused by inefficient SOEs. Most of the reforms, if implemented, are only going to yield results, in two years’ time.
We expect Moody’s to change the outlook on its Baa3 rating of South Africa to negative from stable on 1 November 2019 followed by a downgrade in 2020. Bond yields will likely rise and the rand will weaken against the US dollar; however, both the bond and currency markets appear to have already priced in a potential negative credit rating action. Consequently, should Moody’s take negative rating action as we expect and markets sell-off, markets will likely recover over the next 12 months, depending on the speed of implementation of growth-boosting economic reforms. In the absence of these growth-boosting economic reforms, any sell-off in markets will likely constitute a re-rating of South Africa’s risk assessment.