MOKGATLA MADISHA: Fiscal consolidation delayed yet again

As bond investors, our main interest in the medium-term budget policy statement (MTBPS) can be quite narrow. We are primarily concerned with changes to the funding of the deficit.

We are well aware that tax revenues for the fiscal year are running behind expectations as tabled in the February budget, and that expenditure is running well ahead of budget. To put numbers to it, at the halfway point in the fiscal year revenue is down 0.18% compared with the February forecast of 3.6% growth.

Expenditure is 9.2% higher on a year-to-date basis compared with the 1.2% full-year spending growth forecast. For the February forecasts to be realised, growth in spending in the second half would have to decline and turn negative or tax revenues would have to magically improve.

Both scenarios are unlikely given expenditure is largely wage-bill related, and on the revenue side commodity prices are significantly lower this year, leading to lower taxes from mining companies. Most economist pegged the deficit to widen by R70bn-R90bn. 

As investors we focus on whether the National Treasury’s latest forecasts would be in line with private sector economists or to the extent that they may have better information would their number be smaller or larger, and how it proposes these larger deficits be funded. The Treasury expects the deficit to widen by R54.7bn.  

Market surprise

You can imagine that the market was caught by surprise when the Treasury issued a media statement a little over an hour before finance minister Enoch Godongwana’s speech, announcing that there would be no increases in the sizes of the weekly bond auctions. What would be the point of listening to that speech?  

The market was expecting additional issuance of as much as R1bn a week in nominal bonds, with the difference to be made up by drawdowns on cash reserves and possibly new funding sources such as the upcoming sukuk (Islamic-compliant) bond.  

Before this announcement, long bond prices were about 0.5% weaker but then rallied quite strongly to end the day 1% firmer. The rally was also supported by a strong performance in US bond yields, which incidentally also performed well on the day because the US treasury announced smaller-than-expected quarterly refinancing. That is to say fewer long bonds will be issued.

Notwithstanding an unchanged issuance profile for the rest of this fiscal year, the Treasury’s new gross debt profile forecasts show that the debt-to-GDP ratio is now expected to peak at 77.7% from 73.6% previously. Indeed, many private sector economists do not have a peak in their forecasts but rather see debt levels continuing to climb well beyond 80% over the medium term.

The announcement that municipal debt to Eskom will be written off and that to date applications totalling R56.8bn had been submitted shows that there is a lot of debt in the system, and while not explicitly a government obligation it has no real option but to assume such debt. There was little in this MTBPS about further support for state-owned companies, though we know Transnet has said it needs government support to deal with its R130bn debt burden. 

Default?

We have to ask ourselves: if SA’s debt levels do not stabilise, will the country ultimately default? Obviously that is not our base case. We have long held the view that with high debt levels the bigger threat will be inflation as monetary policy becomes impotent.

For now, SA is blessed with a credible central bank that is sticking to its mandate. However, our clients who see the poor performance of their bond portfolios wonder whether government bonds are worth the risk.

The fact that the market demands such high interest rates from a rand-denominated “risk-free” asset suggests that many investors are uncomfortable with the fiscal trajectory, and the Treasury and government would do well to heed this warning.

The 2023 MTBPS has done little to improve the outlook for local bonds in the medium term. The high funding requirements — at a time when demand for emerging-market debt is declining due to high yields in developed markets and increasing competition for foreign capital from markets such as India — mean yields on SA bonds are likely to have to stay high to attract the marginal investor.  

• Madisha is head of fixed interest at Sanlam Investments.