Tito Mboweni’s (risky) push for growth
Fiscally, SA is looking exceedingly vulnerable. Sustained growth offers the only way out
In a risky move, the National Treasury surprised the markets by abandoning its fiscal conservatism in the medium-term budget policy statement (MTBPS) last week. With the prospect of debt stabilisation receding, SA is back under ratings pressure.
Theoretically, it makes sense in SA’s recessionary climate to shift away from the pro-cyclical policy of recent years (in which disappointing revenues prompted tax hikes) to a looser stance that prioritises growth over debt reduction.
However, charting a path that allows the debt ratio to blow out from 55% to 60% of GDP over the next three years is a gamble that will pay off only if it doesn’t prompt more ratings downgrades and if growth recovers. Those are big "ifs".
Unfortunately, the medium-term budget doesn’t prioritise growth, even after the decision to shift R50bn in spending towards township and rural economies and infrastructure. Most of it goes on a bloated public sector wage bill, education, health and social spending.
Fitch Ratings is not convinced that growth will be reignited. Given the small outlay behind President Cyril Ramaphosa’s economic recovery plan, it expects the stimulus effect to be small. It also thinks that the other growth-enhancing reforms contained in the plan and elaborated on in the MTBPS are "unlikely to alter the growth trajectory significantly".
But the MTBPS has to be read in conjunction with the jobs and investment summits, which represent the first real effort in more than a decade by the government to partner with business to revive growth. That Ramaphosa slayed the term "white monopoly capital" and called business "heroes" at the investment summit last week underscores this shift in approach.
New finance minister Tito Mboweni also hit all the right notes on budget day, emphasising the need for the government to embrace the private sector and find new, joint models of funding and delivery.
He showed a refreshing willingness to slay some holy cows, including suggesting that SAA should be allowed to go to the wall if needs be, saying that SA should consider introducing fiscal rules, and stressing that the Reserve Bank’s independence and mandate must remain sacrosanct.
But the decision to allow the deficit to blow out to 4% of GDP this year and remain at 4.2% for the next two fiscal years, against the previous target of 3.6%, has rattled the markets, causing a sharp sell-off of bonds and the rand.
The weaker fiscal outlook is well below the expectations of Moody’s — the only one of the big three ratings agencies that still has SA rated investment grade.
Moody’s has described the budget as "credit negative". Though it’s likely to delay an outlook downgrade from "stable" to "negative" until after the 2019 main budget and the elections, the political space is so narrow, and the risks building in the fiscal system so significant, that there is little prospect of SA’s fiscal picture improving much in the next six months.
Citibank economist Gina Schoeman is particularly worried about the severe deterioration in the debt-to-GDP ratio and the fact that the primary deficit narrows but no longer closes in the Treasury’s forecasts (see graphs). In the absence of strong growth and low interest rates, a sustained primary surplus will be required to stabilise the debt ratio.
Sanlam Investment Management economic strategist Arthur Kamp has similar concerns: "They say it’s still an attempt at fiscal consolidation in that the primary deficit narrows, but without a marked improvement in the primary budget balance, the fiscal maths does not add up to a stable debt ratio as yet. That implies sovereign-debt ratings risk is back."
So, has SA abandoned fiscal consolidation or just hit the pause button?
Mboweni is emphatic that SA remains committed to fiscal consolidation, and has vowed to ensure that public debt stabilises and is reduced as soon as possible. "SA must choose a path that reduces the structural deficit, especially the consistently high growth in the real public sector wage bill," he says. "We cannot continue to borrow at [such a] rate".
But the MTBPS has not chosen this path: the structural deficit will rise, debt stabilisation is ephemeral and debt servicing costs will climb from R181bn (3.6% of GDP) now to R247bn (3.9%) by 2021/2022.
Though it seems the Treasury has abandoned its dependable conservatism and risk aversion, it in fact worked hard to hold the line even to the extent that it has.
First, it has refused to cover the R30bn overrun of the state’s compensation bill. Departments must absorb the additional cost through voluntary severance, natural attrition, better management of overtime and other "efficiencies".
While this attempt at fiscal discipline is to be welcomed, departments are likely to cut capital expenditure or goods and services budgets to pay salaries. Service delivery will invariably be affected.
Second, the Treasury has budgeted conservatively for real GDP growth and revenue collection, stripping out R85bn in revenue over the next three years, lowering its tax buoyancy and tax-base growth estimates and not pencilling in anything for the spectrum auction proceeds due next year, though it could net R15bn.
Third, SA will remain within its expenditure ceiling. The reason for the steep deterioration in the deficit comes down to slower expected revenue growth rather than overspending.
The problem is that the ceiling is not a flat line. It allows expenditure to continue growing by almost 2% more than inflation over the medium term.
Given that R85bn has been stripped out of revenue, it stands to reason that R85bn should have been knocked off expenditure to realign the pace of spending growth to the country’s more subdued economic prospects. According to the Treasury, SA’s long-run economic growth must average at least 2.5%-3% to sustain current spending commitments.
"In an ideal world, expenditure would have been cut. However, in our view this was never going to materialise in this MTBPS given populist pressures to spend more, the looming elections and fractious internal politics within the ANC," says Schoeman.
This raises the question of whether hitting "pause" on fiscal consolidation was a justifiable academic decision in view of the recession, or something the Treasury was forced into by political pressure.
SA’s failure at fiscal consolidation wouldn’t matter so much if the risks building up in the fiscal system weren’t so elevated
It was probably a bit of both.
SA has been attempting fiscal consolidation for years, but reducing the wage bill has proved politically impossible.
Reducing expenditure has proved almost as hard, given the social spending pressures related to sky-high unemployment.
The approach of hiking taxes to cover revenue shortfalls has run out of road given the backlash against the VAT hike and weakness in personal and corporate income tax collection.
The Treasury has clearly decided that increasing taxes further could be growth-sapping and counterproductive. Hence the decision not to raise taxes in 2019 unless economic conditions improve.
On the plus side, Mboweni’s appointment will strengthen the Treasury’s backbone. But while he may be able to detonate a few "truth bombs", especially on the need to reimagine the state-owned-enterprise (SOE) business model, this doesn’t mean the rest of the government is on board, says Intellidex head of capital markets research Peter Attard Montalto.
"Political capital fundamentally does not yet exist within the government or the ANC to undertake the difficult restructuring of SOEs," he says.
What it means
Allowing debt to balloon is a gamble that will pay off only if growth recovers
And don’t expect the fiscal maths to look any better come the February budget.
"There is no political power for the National Treasury to do more on the consolidation front," he says. "The politics means we broadly get stuck here."
SA’s failure at fiscal consolidation wouldn’t matter so much if the risks building up in the fiscal system weren’t so elevated. Provinces owe R25bn to national government; municipalities’ arrears to Eskom, water boards and other agencies exceed R23bn; medical malpractice claims top R80bn and are climbing by 32% a year; and the top 10 SOEs will need to borrow more than R1-trillion over the medium term. Several will require bailouts indefinitely.
"There is a constant view that a budget or MTBPS is as bad as it gets and from here things will only get better. This is demonstrably not true," says Attard Montalto.
"Against a backdrop of tightening global liquidity, rising ratings pressure and the risks to the fiscus posed by politics, the weak financial position of SOEs, and the funding requirements of free education and [national health insurance], my view is that the deficit will remain stuck at or just under 4% of GDP and debt won’t stabilise inside of 60% over the medium term.
"SA’s downgrade to junk status by all three main ratings agencies is only a matter of time."
In short, the model of (corrupt) state-led development has left SA fiscally exhausted and is pushing the government to embrace the private sector as a last resort. The MTBPS and the two summits, with their emphasis on drawing in the private sector to help the state deliver, are an attempt to do just that. That business pledged almost R300bn in new investment at last week’s investment summit is a promising sign, but to really ignite growth it must be backed up by ongoing reforms that raise competitiveness and ease the cost of doing business.