For all to see, South Africa’s finances are in dire shape. Ten years of weak growth, mismanagement and corruption has led us to this point. Historically SA had one of the lowest debt-to-GDP ratios in the world, but now we have one of the highest across emerging markets!
South Africa desperately needs structural reforms, Tito’s budget was brave and can work but only time will tell whether the President and Cabinet have the same courage as our Finance Minister and actually implement the reforms that are desperately needed.
So, what are investors to do? It is simple, and something that we have recommended for more than a decade now, i.e. offshore. Since 1971 the Rand has lost 6.52% per annum (see graph below) and our JSE has lagged the MSCI by around 8% pa over the past ten years. Compound this, and these numbers become staggering. In order to protect one’s global purchasing power one needs to ensure that you diversify and build up a portfolio that will withstand a deteriorating local economy and Rand.
Do not be an ostrich…
SA’s fiscal reckoning has arrived
A Herculean effort will be required to put SA back on a fiscally sustainable path. The supplementary budget takes the first step, but the challenge cannot be overstated: SA is facing a fiscal reckoning at a time when the economy has never been weaker. The odds are not in our favour…
It has taken the Covid-19 crisis to push SA to this point, but finally, after years of prevarication, the government has accepted that SA’s public finances are dangerously overstretched and unprecedented spending cuts, coupled with deeper economic reforms, are needed to avoid a sovereign debt crisis.
The cabinet has been scared into accepting this prognosis from finance minister Tito Mboweni by the Covid-induced collapse in SA’s fiscal ratios. Based on National Treasury’s estimate that real GDP growth will contract by 7.2% in 2020, the consolidated deficit will double to 15.7% of GDP, and gross debt will exceed 81% of GDP in the current fiscal year.
This will place public debt on such a steep upward trajectory that, unless extreme countermeasures are taken, the debt ratio will pierce the 100% mark by 2023/2024, inviting a debt crisis that would unravel all the social gains SA has made over the past 26 years.
“If we remain passive, economic growth will stagnate. Our debt will spiral inexorably upwards and debt‐service costs will crowd out public spending on education and other policy priorities,” Mboweni said in his budget speech on Wednesday.
This fiscal year, with higher spending commitments and tax revenue set to fall R300bn short mainly due to Covid-19, government is planning to borrow over R400bn more than it needed in February. In short, during 2020/2021 SA will borrow about R2bn a day while spending R5bn a day. In 2019/2020, the country was borrowing R1.2bn a day while spending R4.5bn a day.
A sovereign debt crisis occurs when a country can no longer pay back the interest or principal on its borrowings, explained Mboweni. “We are still some way from that. But if we do not act now, we will shortly get there.”
The problem in having let matters build to such a head, after years of overspending in a slowing economy, is that the degree of fiscal austerity required to stabilise the debt ratio has become so huge it could throw the economy into reverse.
The February 2020 budget dodged this bullet by failing to budget for debt stabilisation. Continuing to do so now was no longer an option: Mboweni desperately needs to borrow $7bn from international lenders, including the International Monetary Fund (IMF), to plug the funding gaps caused by SA’s R500bn Covid relief scheme. But to do so he needs to show that the country is fiscally sustainable.
This means presenting a credible plan to get debt to stabilise way before it gets to 100% of GDP. The supplementary budget tries to do that, though it defers the detail on the policy measures required to kickstart growth to the medium-term budget in October.
However, it is one thing to admit that you have a problem and promise to fix it; it is quite another for this government to bite the bullet on tough issues such as SAA, Eskom and public sector wage cuts, or to cease providing services to needy communities reeling from the impact of the coronavirus.
This is what makes the huge R250bn fiscal adjustment Mboweni has pencilled in over the next two years to stabilise the debt ratio at 87.4% in 2023/2024 so hard to swallow – especially at a time when fiscal risks and socioeconomic hardship are rising steeply.
To the National Treasury’s credit, it has budgeted conservatively for growth and inflation. It is looking for a 7.2% contraction in real GDP this year, followed by a rebound to 2.6% next year (partly due to base effects), but then it expects the economy to slump back to just 1.5% in both 2022 and 2023.
This is the first time in a decade the Treasury has failed to rely on an automatic upswing in its medium-term growth forecast to deliver the revenue required to moderate the deficit. These forecasts are more conservative than those of the Reserve Bank, which is looking for growth of -7% this year, followed by 3.8% and 2.9%.
Also positive is that, of the R250bn required adjustment, R230bn will come in the form of spending cuts, keeping tax hikes to just R15bn to minimise the impact on economic growth. But, of course, this assumes the R160bn in savings to the wage bill can still be achieved – another long shot, given the legal dispute between government and public sector unions over the existing three-year wage agreement.
In short, such an aggressive act of fiscal consolidation, though unavoidable, is hardly credible. Since 2014, all SA’s fiscal consolidation efforts have cut only R70bn from noninterest expenditure. Now, government is undertaking to cut R230bn in two years during the worst recession since the 1930s.
Mboweni would no doubt have preferred to spread the adjustment over 10 years but at the rate debt is mounting, a gentler approach was simply not going to cut it – not with the markets, nor the IMF.
“Without significant policy action, the economy is too weak – and the stock of debt too high – for GDP growth and revenue to recover sufficiently to stabilise government debt,” explains the Supplementary Budget Review.
It adds that with Covid-19 having destroyed productive capacity in the economy, even “deeper reforms” than previously outlined will be required to meaningfully lift growth over the next five years.
WHAT IT MEANS: SA must undertake severe austerity to restore fiscal sustainability or risk a debt crisis
These reforms must improve productivity, lower the cost of doing business and reduce the dominance of state-owned entities (SOEs) in network industries, as well as their relentless demands on the public purse, it states. In fact, it calls for the number of SOEs to be rationalised, for some to be merged and for certain functions to be absorbed into government, warning that future bailouts will be “strictly conditional” on them improving their balance sheets. (Mboweni’s silence on further funding for SAA was deafening.)
We have been here so many times before that it is hard to take these kinds of commitments at face value. But this is the first time a finance minister has warned that if government doesn’t change the way it does things, some SOEs will likely collapse and the country itself will need a bailout.
Mboweni is right in saying a “Herculean” effort will be required to put SA back on a fiscally sustainable path. The supplementary budget takes the first step, but it also shows just how high the mountain is that SA must climb.
Even before the virus struck, the three major credit ratings agencies had concluded that SA would not succeed in turning itself around. It does seem improbable that the country will do so now. The bottom line is that what government does over the next six months will determine whether SA succeeds or fails. The country’s moment of reckoning has arrived.
(Source: Moneyweb, June 2020)