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Investment views

MTBPS paints bleak picture that will disappoint both market and ratings agencies

26 October 2017

By Nazmeera Moola, co-Head of Fixed Income, Investec Asset Management

Listen to Nazmeera Moola, co-Head of Fixed Income at Investec Asset Management, unpack the Medium Term Budget Policy Statement. You can also read her views below.

The Medium Term Budget Policy Statement (MTBPS), presented in Parliament by Finance Minister Malusi Gigaba, paints a bleak picture: the expenditure ceiling has been breached, there is no primary surplus and debt and guarantees combined are above 60% of GDP. Not only is the market likely to hate it, but Standard & Poor’s may well downgrade our domestic credit rating in November.

This MTBPS is a clear acknowledgment of National Treasury’s limitations and starkly lays out the likely path if no dramatic action is taken to address public sector wages, governance at state-owned entities and economic growth in the next six months.

The market and rating agencies will hate:

  • That the expenditure ceiling has been raised by R3.9bn in the current fiscal year due to bailouts at both SAA and the South African Post Office. However, the Minister indicated that a portion of its Telkom shares would be disposed of to avoid a breach, with an option to buy them back at a later stage.
  • The R122bn increase in net domestic bond issuance over the next three years and total increase in debt issuance of R149bn in the same period.
  • The lack of expenditure cuts in the period and the decline in the expenditure ceiling in coming years that is solely due to a smaller contingency reserve. Aside from the R3.9bn increase in expenditure in the current fiscal year, there are minimal planned expenditure cuts in the next three years. In addition, clear upside risks to expenditure were highlighted.
  • The SA main budget will remain in primary deficit through the forecast horizon, essentially flat-lining at -0.7% of GDP.
  • The sharp increase in the projected main budget deficits, from 3.5% of GDP in the current year to 4.7% and from 3.3% to 4.5% in FY18/19.
  • No stabilisation in the debt-to-GDP ratio over the forecast horizon. Net debt to GDP plus guarantees we breach 60% in the next two to three years.

S&P have cited two key drivers to their SA rating. Firstly, they need to see fiscal consolidation over the medium term. Unfortunately, this MTBPS produces no evidence of this, as debt to GDP continues to rise over the medium-term. Secondly, they want comfort that state-owned enterprises do not present a major risk to the sovereign balance sheet. While the increase in the expenditure ceiling caused by the SAA bail-out could be repaired by the sale of some Telkom shares, decisive action is needed by the Minister of Communications.

Moody’s also cited two key drivers to their SA rating: Firstly, adherence to the expenditure ceiling, which has now been breached and the need to see a growth plan. Hopefully, today’s MTBPS will spur some much-needed action in the area.

Read together, the Medium-Term Budget Policy Statement and Minister Gigaba’s Budget Speech starkly lay out the choices South Africa faces. Without hard political decisions, South Africa’s gross-debt-to-GDP breaches 60% in four years. Net debt-to-GDP will breach 55% in three years. Add in guarantees to net debt, and the total is over 60% in two years.

Previously the National Treasury attempted to lead the rest of government by pre-announcing measures that they believed were important to enable fiscal consolidation and higher growth. In contrast, this MTBPS acknowledges that Treasury is powerless to make the hard decisions that are required. These decisions need to be made by the broader cabinet. It is a high risk strategy that markets and the rating agencies could dislike intensely. However, it is a fair reflection of the current political environment.

There are essentially three critical areas that need to be addressed to stabilise the budget. Firstly, public sector wages need to be controlled. The two problems relating to public sector wages are the persistently high above-inflation wage increases and the dramatic growth in senior management positions, particularly amongst teachers, nurses and police.

Secondly, governance at state-owned enterprises needs to improve quickly to help stabilise the finances at these entities. After years of mismanagement, several state owned companies are facing liquidity and/or solvency issues. The most notable is Eskom, which has utilised R250bn in government guarantees and has another R100bn unutilised. Until the governance of state owned companies is resolved, the problems of corruption, instability of management and opaque targets will continue.

Finally, boost South Africa’s growth rate. The divergence between the performance of the global economy and the local economy over the last two years is entirely due to South Africa’s dysfunctional political environment. The speech states that “Demonstrative actions that build business and consumer confidence can encourage global and domestic investment, broaden private-sector activity and boost competitiveness.” This is exactly what is needed to encourage businesses to invest and consumers to spend. In contrast, there have been many recent actions by cabinet ministers that exacerbate the lack of confidence, including a mining charter that stunts future investment, the touting of an unaffordable nuclear plan and little demonstrable commitment to resolving governance at Eskom.

If South Africa’s growth rate averaged 2.5% in 2018 and 2019 and 3% thereafter, net debt to GDP plus guarantees would stabilise at just below 60% of GDP. On the other end of the scale, if growth were to contract by 2% in 2018 – an entirely plausible outcome if the ANC electoral conference produces a negative outcome – the debt ratios would breach 60% next year.


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