The long road to debt reform: SA’s Budget underwhelms bond investors
Despite the positivity priced into the Budget from the much-publicised tax revenue overruns, the outcome has positively underwhelmed South African bond investors. Twenty-year bonds sold off by 2% in price terms to a 10.6% yield in the aftermath of the February meeting.
Government revenue has overshot expectations in the current financial year by R66bn. The reason for this is once again quite simply a commodity story. Strong prices are providing near-term fiscal relief: If you look at SA’s key resources of rhodium, iron ore, platinum, palladium and gold, the rand value of what we have exported is double that which was exported in 2019. Corporate income tax collection is booming.
Beyond this, there isn’t very much to get excited about. Government’s cash balances are healthy right now, but debt stabilisation rests on sticking to the spending plan and growth-enhancing reforms. The latter is difficult to implement, and even more problematic is that there can exist a trade-off between these two goals if one assumes that public sector spending can stimulate growth (the room is divided on this one).
The biggest challenge in tangibly reducing debt lies in whether government will spend or save the current tax revenue overruns they have received. From the numbers tabled, it appears that they are going to be spending down a large portion of the R377bn in revenue overruns expected over the next four years on various items that seem to have become recurrent – like social relief distress grants, further state-owned enterprise (SOE) allocations, public sector wage gratuities, health, education, and infrastructure. While some of these items are sorely needed, fiscal consolidation and debt reduction still require spending constraints. To bake in permanently higher expenditure sets a risky precedent, especially if one is pinning ones hopes on commodity prices and funding oneself at a 10% interest rate on bonds while growing the economy at 6% in nominal terms.
The effect of the above is that the medium-term expenditure framework projects a total public sector borrowing requirement of R439bn, R370bn and R340bn in each of the next three years. Rand bond issuance in the next financial year is forecast to rise from R285bn to R330bn. This is a lot of funding for the local market to provide alone given the growth of savings is likely to be tepid at best. While foreign investors have been forthcoming with portfolio inflows this year, with some referring to South Africa as the “Switzerland of the emerging markets” in turbulent geopolitical times, their sentiments can be fickle.