South Africa: A fiscal upside scenario
Following on from our meaningful upgrades to South Africa’s growth outlook on stronger cyclical (global) tailwinds (see South Africa: Moving on up, dated 10 June), we have now also updated our fiscal assumptions and scenarios for the country.
The bottom line is that we believe higher levels of nominal growth and GDP inflation should prove an important boon for tax revenues over the medium-term – we see a scenario of up to 5pp of GDP (cumulative) in nominal revenue improvement relative to the Treasury’s budget baselines. An earlier return to a primary surplus in the next 3 years now seems in reach to us.
Spending restraint remains key, though:
This requires the Treasury to stick to its real expenditure reduction promises outlined in February (-3.5% real growth p.a. in non-interest spending over the medium-term).
The potential ‘flies in the ointment’?
The country has scheduled local government elections scheduled for 27 October amid many municipalities in financial dire straits; there are rising socioeconomic pressures (eg. calls for a basic income grant for the mass unemployed); public sector unions and the state remain far apart on wage demands for 2021 and beyond; and Covid 3rd and potentially 4th waves prompting lengthier lockdown restrictions – all of which may make it more tempting to spend some of the additional revenue windfalls.
Does the start of lockdown level four spell doom and gloom for the economy?
The aim of new restrictions is to strike a balance between keeping the economy open, but at the same time limit mobility and provide a window for struggling healthcare facilities to ramp up their high care and ICU facilities.
These measures are to be expected given the inevitability of the 3rd wave spikes and coming peaks. The new restrictions still stop far short of the wholesale shut down of the economy this time last year, though, and is therefore unlikely to have as large implications for the economy right now. BUT an important caveat here is that the next 14 days will be critical as restrictions could be lengthened and strengthened should numbers continue to worsen considerably.
We believe that should the latter scenario pan out (and further extensions to the level 4 lockdown continue beyond the initial 14 days), there could be some short term additional fiscal support measures put in place should the latter materialize (perhaps an extension of the social relief of distress grant for a month or two), but importantly we note that ZAR 16.2bn has already been put aside in contingency for Covid related support for additional waves and ramped up vaccine roll out.
On the vaccine roll-out, the daily numbers continue to move in the right direction at least, with last week seeing a new peak in daily rollouts (>115k), with the pace likely to pick up momentum now that the private sector are also involved and 2.6m new doses arrived last week (just under 3m people out of a population of 60m have now been vaccinated).
We address all of this and more in our latest fiscal thematic below. Of course aligned with our macro views is our EM strategy team’s latest thinking on how to play this from a markets perspective:
We continue to like ASW in SAGBs (2032s) and also continue to hold South Africa as a currency and bond duration overweight in our model portfolio.
Please click here to access the full note – highlights include:
Growth upgrades and stronger GDP inflation suggest meaningful improvements to our view of South Africa’s fiscal consolidation prospects.
With nominal GDP, corporate tax and VAT receipts already back to pre-Covid levels, our projections suggest that cumulative revenue in the next 3 fiscal years might be 5% of GDP higher than the budget baselines.
If there is no slippage from planned real expenditure cuts, the primary budget balance could return to surplus earlier than we previously expected.
Such cuts might be jeopardised, though, by pressure to spend more in a local government election year, poor municipal finances and further Covid waves.
In our view, the improving fiscal picture creates a positive backdrop for SAGBs. We continue to like long asset swap spread positions in R2032s.