The MTBPS paints a disturbing, if accurate, fiscal picture
It was, indeed, a difficult speech to deliver, but with clear political constraints hampering brave fiscal reform
Reaction to finance minister Tito Mboweni’s much-anticipated second medium-term budget policy statement (MTBPS) has been mixed. While drawing praise for his straight talk, the minister came under fire for the dearth of solutions in his presentation. He certainly pulled no punches in painting a decidedly gloomy fiscal picture.
It was disappointing, however, that he failed to reveal any clear action plan to address the three most crucial issues crippling our economy: fiscal slippage, state expenditure and debt stabilisation.
It was with a wry smile that I read former DA leader Tony Leon’s observation in Business Day in which he stated that “this [medium-term budget] is the grimmest and most difficult in a generation.” If I consider our views after the budget speech in February, I’m not sure much has changed since then. We noted that all the important fiscal ratios were pointing in the wrong direction, while at the same time, South Africans were urgently demanding improved service delivery. The local economy was struggling to grow at a rate faster than consumer inflation, the Eskom debacle was tangible, and the numbers were frightening.
Mboweni thus had to present his first budget to parliament in a challenging economic and political environment. Leading up to the event, we all speculated whether he would be brave enough to address the obvious overspending on government consumption to reduce expenditure in relation to GDP that would ultimately stabilise government debt levels in 2023/2024.
Our conclusion was that while the narrative looked promising, the numbers remained deeply concerning — and the margin of error too small for comfort.
As 2019 unfolded it became obvious that our scepticism was not unfounded. Hence, Leon’s observation. The minister, quite frankly, still faces exactly the same challenges he did in February. The only difference is that he now has more realistic numbers to work with in the fiscal prudence balancing act — with no economic tailwinds from an income perspective.
Most important, the medium-term budget is another policy intervention in which the minister had to show his hand on the likely fiscal and economic paths of the Ramaphosa administration. The market is looking for guidance or information in the following areas:
- Fiscal slippage. Underperforming tax revenues and the financial support for Eskom and other state-owned enterprises (SOEs) is likely to result in a main budget deficit of more than 6% of GDP.
- Details on expenditure. Although the income side is important, the focus of the market is on the details of how the government plans to reduce expenditure in an extremely fragile political environment. The key is the credibility of these plans. The market is demanding details, since we’ve seen that numbers on paper don’t equal action.
- Debt stabilisation. The gross debt-to-GDP ratio has escalated to alarming levels. The market is clearly looking for measures that would suggest the National Treasury is serious in its efforts to arrest the upward trajectory of the debt level. Our initial response regarding these three areas is one of disappointment.
The immediate revenue shortfall and spending cuts, as well as the fiscal year 2019/2020 main budget deficit (6.2% of GDP) match our own, as well as market forecasts.
However, the medium-term fiscal projections have worsened materially and also relative to expectations, as the Treasury has effectively made politicians responsible for negotiating the significant interventions required to achieve its proposed new fiscal target of a main budget primary balance (revenues equal to non-interest spending, excluding Eskom support) by 2022/2023. The main budget deficit is forecast to widen to 6.8% of GDP in 2020/2021 from the new 6.2%.
We fully acknowledge that politicians can hardly claim historic success when it comes to expenditure challenges.
Details on expenditure
As stated above, we expected the minister to be realistic about income, since measures to boost it over the short term are rather limited. Tax revenues are projected to be a disappointing R52.5bn less than the 2019 budget estimates in 2019/2020 and R84bn in 2020/2021. The 2020/2021 forecasts are more conservative than ours, which would suggest an extreme soberness on the part of the minister.
This shortfall implies that the minister has had his work cut out on the expenditure side to address the shortfall. However, for 2020/2201, the main budget non-interest spending still increases by R23bn owing to the additional injections for Eskom (announced after the 2019 budget), but spending is now projected to be R8.2bn lower in the following year.
In 2022/2023, spending will grow in line with consumer inflation, in other words, there will not be real spending growth.
The focus of these savings efforts is on improving efficiency and reducing wasteful expenditure, while government claims it will:
- Dispose of unused land and other assets.
- Manage the benefits received by political office bearers through reforms to the Ministerial Handbook.
- Initiate work to limit claims against the state (including accelerated implementation of the Road Accident Benefit Scheme).
- Merge and consolidate entities and regulatory agencies.
Proposals to consider in reducing the government wage bill include pegging the cost-of-living adjustments at or below consumer price index (CPI) inflation, halting automatic pay progression, and reviewing occupation-specific dispensation for wages. Progress after discussions with labour will be announced in the 2020 budget. These are hardly proposals that will move the economic needle.
A major disappointment was the absence of a detailed financial strategy for Eskom, and other financially troubled SOEs. “Some debt relief will be provided to Eskom over time, as operational and financial performance improves,” the minister said. Cost reductions and progress with the unbundling process are two of the prerequisites for any such considerations. This debt-relief process will be managed to ensure “any default and cross-default on total Eskom debt is contained” and creditors “are treated equitably”. Most operational changes are expected to be implemented before the end of 2021.
The biggest disappointment and shock was the revised gross debt-to-GDP path projections:
Source: National Treasury
Total gross loan debt is budgeted to rise to a revised 60.8% of GDP in 2019/2020, much higher than the 56.2% forecast in the February 2019 budget, and to continue rising to 71.3% in 2022/2023. Even excluding Eskom bailouts, the figures are unflattering, with a move to 68% over the period. Financing will remain mainly longer term and sourced in domestic markets.
Financial markets responded aggressively to the lack of detail in terms of expenditure intervention and the financial strategy regarding Eskom, as well as fundamentally different projections of the medium-term debt-to-GDP ratio.
The rand fell sharply from its opening levels of R14.62/$ to R15.02/$, and the yield on the R186 — the seven-year government bond — sold off from 8.21% to 8.42%.
Investors are obviously concerned about the medium-term funding implications of the increased debt levels and the view that rating agencies are likely to take on the mentioned concerns. When the Treasury previously published an MTBPS that set out the unsustainable fiscal path SA would travel in the absence of decisive intervention to change course, S&P downgraded SA’s sovereign ratings while Moody’s placed our country’s rating on review.
A change in the rating outlook from Moody’s would probably not be market-moving, as markets are arguably already discounting a downgrade. It’ll indeed be the substantial deterioration in the fiscal forecast, which is significantly worse than investors expected, that will likely trigger pressure on the currency and bond prices.
The equity markets’ response was quite predictable given the slide of the rand. Rand-hedge shares responded positively while the SA Inc complex, such as the banks and retailers, came under pressure after a recent bounce in these prices. If we witness a continuation of extreme price movements of individual counters, it may well trigger action in our portfolios — we will sell expensive shares and buy shares that are unfairly penalised.
A final note: It was, indeed, a difficult speech to deliver. Our observation is that the minister painted an extremely sober fiscal picture, but with clear political constraints hampering brave fiscal reform. Maybe this was his way to get his urgent message across to his co-parliamentarians.
“Now is the time. We cannot wait any longer. If we want a successful harvest, we must act today.”
We trust there will be more evidence of political will to intervene to get SA back on a sustainable fiscal path when the minister delivers his budget speech in February 2020.
• Van der Merwe is director of investments at Sanlam Private Wealth.
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