THE BIG PICTURE: Aloe darkness my old friend
Faced with the impossible choice between holding the line on fiscal discipline or supporting Eskom, the National Treasury chose to keep the lights on. But the drain on the fiscus of propping up SOEs is fast becoming unbearable
The mess at Eskom has blown the budget out of the water, forcing Tito Mboweni to be the first finance minister to breach the National Treasury’s sacrosanct expenditure ceiling — a move that will reignite ratings pressure and disappoint the markets.
It is the first time since the ceiling’s inception in 2012 that SA has been unable to stay within its spending envelope. This is a troubling landmark that raises grave doubts over SA’s ability to return to fiscal sustainability in the absence of severe adjustments to spending or taxation.
The bottom line is that economists’ worst fears about the fiscal risks posed by state-owned enterprises are coming to fruition — and the Treasury is battling to push back against their demands.
Forced to provide a 10-year bailout of R150bn — or R23bn annually over the medium term — to the effectively bankrupt utility to keep SA’s lights on, the Treasury was damned if it did and damned if it didn’t. The alternative would have spelt disaster for the economy.
The immediate concern is that Moody’s, the only major ratings agency to still rate SA as investment grade, will junk the country at its next review on March 29. The markets certainly appear to think so, with the rand initially falling by slightly more than 1% against the dollar after the budget was revealed, though it has since recouped some of its losses.
Mboweni has done his utmost to guard against a Moody’s downgrade by insisting that, in return for the handout, Eskom will effectively be put under "curatorship".
A "chief reorganisation officer" will be deployed in Eskom and each SOE receiving bailout funds or requesting a loan guarantee for operational purposes.
This person will be the Treasury’s "eyes and ears" and help ensure that the institution undertakes the restructuring required to become financially self-sufficient.
"Pouring money directly into Eskom in its current form is like pouring water into a sieve," said Mboweni in his budget speech.
Earlier, at a press briefing, he left journalists in no doubt that the Treasury has lost patience with loss-making SOEs and that they will be subject to much stricter oversight from now on.
However, it is unclear whether statements of fresh resolve will be good enough for Moody’s.
Nazmeera Moola, deputy MD of Investec Asset Management, believes a far more plausible plan on Eskom’s turnaround is required in the next few weeks to prevent Moody’s from moving SA’s outlook to "negative".
"Moody’s noted after the state of the nation address that the SA government taking on Eskom liabilities (either directly or indirectly by providing support) would only be viewed as neutral if it were accompanied by a cost-reduction plan that could be implemented imminently," she explains. "This needs to be produced."
To take care of Eskom, the state has incurred significant fiscal slippage. This has been compounded by disappointing economic growth and higher-than-expected VAT refunds. The upshot is a huge R42.8bn revenue shortfall in the current fiscal year.
As a result, SA’s deficit targets will be widely missed — the consolidated deficit will hit a frightening 4.5% of GDP this year — and debt service costs will blow out from R202bn to R247bn by 2020/2021, gobbling up 4% of GDP in that year compared with 3.6% now.
As Mboweni explained in his speech, SA will borrow R1.2bn a day over this period while spending R1bn a day on interest charges.
To symbolise this bitter situation, Mboweni walked into the National Assembly with an aloe ferox or bitter aloe plant — a sharp contrast to the sweet plums former finance minister Trevor Manuel once brought into parliament.
However, his message was constructive, promising that though times are tough, SA is as resilient as the aloe plant, and by planting anew the good times will return. "We must take the bitter with the sweet," he said.
The problem is the fiscus is now so constrained that very little fresh planting can be done. Of the R75.3bn in new spending budgeted for over the medium term, almost R70bn will be to cover Eskom’s interest bill, leaving only an extra R5bn for the new infrastructure fund and R1.3bn to run the 2021 census.
To offset this, baseline expenditure will be cut by R50bn, taxes will be raised by another R25bn, despite the slowing economy, and the contingency reserve will be run down by R2bn over the medium term.
The 15c/l increase in the general fuel levy, higher excise taxes, a new carbon tax and the failure to offset bracket creep or adjust the medical aid tax credit mean SA’s fiscal stance is tightening, even though none of the big tax categories (VAT, corporate and personal income tax) have been increased. This will further depress economic activity after the economy got off to a sluggish start for the year.
"The persistent resort to personal income tax measures (even if by stealth in not adjusting tax brackets) will be negative for the consumer and will further pressure the tax base," warns Absa economist Peter Worthington. "High-income earners tend to be the most mobile internationally and to have access to the most aggressive tax planners."
But even after modest tax hikes and spending cuts, it has proved impossible to prevent the spending ceiling from being breached by R16bn over the medium term.
Were it not for the Eskom bailout, SA would have met (or bettered) its consolidated budget deficit target of 4% of GDP this year and been on track to getting debt to stabilise at under 60% by 2023/2024. Instead, the deficit is expected to be 4.2% this year, rising to 4.5% next year and only coming back to 4% in 2021/2022.
"It’s a big miss," says Sanlam Investment Management economist Arthur Kamp. "I am concerned that the balance sheet of the state has so deteriorated because of the way we’re dealing with Eskom that it’s going to be very difficult to keep us on a sustainable fiscal path without considering measures like equity partners and privatisation."
For Moola, the 2019 budget reflects "10 years of poor budgeting and kicking the can down the road".
This is best illustrated by the decline in the SOE sector’s average return on equity, from 7.5% in 2011/2012 to -0.3% by 2017/2018, which suggests the government is losing money across its portfolio of companies.
Despite everything, gross debt is still expected to peak at roughly 60% in 2023/2024, as before. However, given the regularity with which the Treasury has missed its previous debt targets, outer-year estimates tend to lack credibility.
Ian Stuart, who heads the Treasury’s budget office, believes the credibility of the fiscal framework has been well safeguarded, especially on the revenue side. In total, R16bn has been knocked off the Treasury’s revenue estimates over the next three years.
The Treasury has also cut its GDP forecasts, reduced its tax base and tax buoyancy assumptions, and factored in no revenue gains from the restructuring of the SA Revenue Service (Sars) or from the spectrum auction, even though the latter two items should net many billions.
Hopes are high that the urgent moves outlined in the budget to re-establish the large business unit in Sars, as well as to create an illicit economy unit and appoint an inspector-general for tax administration, could boost tax collection significantly.
The Treasury now expects real GDP growth to average 1.5% this year (previously 1.7%), rising to 1.7% in 2020 (previously 2.1%) and 2.1% in 2021 (previously 2.3%).
It has also published four alternative growth scenarios in which the economy does decidedly better — or worse — than this baseline projection.
In the best-case scenario, SA implements all the reforms outlined in the budget and succeeds in lowering the cost of doing business and boosting confidence, investment and competitiveness. Growth comes close to 3% by 2021.
In the worst-case scenario, weak growth, widening fiscal deficits and an inability to stabilise Eskom lead to a fiscal crisis and a local-currency downgrade. SA enters a recession in 2019 and 2020.
In a less-bad but quite plausible scenario, Eskom is slow to get on top of its problems, leading to extended load-shedding which pulls GDP down to just 0.2% this year. As electricity capacity is restored, GDP growth recovers to 1.9% in 2021.
The biggest risk to the fiscal framework is that the Treasury’s latest revenue and growth forecasts fail to materialise. If growth recovers to 2.1% over the next three years, the budget will hang together. But the Treasury’s track record as a forecaster is poor, having overestimated real GDP growth for nearly every year in the past decade.
The Budget Review contains the ominous warning that "if economic growth does not strengthen in the period ahead, more difficult fiscal adjustments will be required to return the public finances to a sustainable path".
The second major risk to the fiscus is SOEs could require more funding than envisaged.
According to Treasury officials, the numbers coming out of Eskom for maintenance and other costs are opaque and highly uncertain. The Treasury is hoping that the division of the utility into three separate units will inject significant transparency into its cost structure.
In the absence of better data, the Treasury based its annual bailout of R23bn just on the cost of covering Eskom’s interest and redemption requirements.
"The worst situation would be persistent load-shedding over the year," says Stuart. "The R23bn gives them a breather so that they can focus on operational issues, not capital raising."
Says Moola: "The National Treasury is unwilling to take on [a significant portion of Eskom’s debt] as they believe it would [encourage] the wrong behaviour."
The Treasury has also set aside R6bn in the contingency reserve in 2019/2020 to aid SAA, the SABC and the SA Post Office, but this must be raised in a deficit-neutral manner through the sale of noncore assets.
This amount is far short of the demands being made by these SOEs. SAA alone is looking for at least R16bn, but as this would be enough to wipe out the airline’s entire debt stock, it is unlikely to be countenanced by the Treasury.
The third major fiscal risk is that the public sector wage bill fails to moderate to the extent budgeted for. The Treasury is targeting wage bill cuts of R5.3bn, R11bn and R10.7bn in each of the next three years respectively.
Stuart is confident the government can achieve these targets based on the progress achieved over the past year, coupled with a new early retirement scheme; limits on overtime, pay progression and bonus payments; and the freezing of wages in the national and provincial legislatures. Last year, the state’s monthly payrolls showed about 16,000 fewer employees on average compared with the same months in 2015.
Even so, the total wage bill is still set to grow ahead of inflation, by 6.8% over the medium term. At 34.4%, it will remain the largest category of total spending.
Asked during the press briefing whether Moody’s is likely to downgrade SA, Mboweni said the conversations with the ratings agencies are proving "very, very difficult". In his view, Moody’s should view as positive the steps being taken to fix Eskom and lower the wage bill.
Other positives are that inflation remains within the target range and that "green shoots" of recovery are evident in the economy.
Reserve Bank governor Lesetja Kganyago added that the central bank has conducted stress tests and is confident SA’s banking sector can withstand a prolonged growth slowdown induced by a junk rating from Moody’s.
The immediate impact, he explained, would be SA’s government bonds being ejected from the world government bond index. This would raise the cost of borrowing for both the government and the private sector, which would retard investment, jobs and growth.
Despite the grim reading that is the budget, it’s clear the Treasury has tried hard to moderate expenditure and keep tax increases to a minimum. There are even pockets of good news in the surprising reduction in the wage bill.
However, the drain on the fiscus from loss-making SOEs is fast becoming unbearable, and unless the government takes dramatic action to reform the sector, SA’s fiscal fortunes will continue to decline.