27 October 2017

South Africa: Walking an Even Tighter Rope - a Mid-Term Budget Review

analysis

Finance Minister Malusi Gigaba was unambiguous on Wednesday when he outlined the current dismal state of the South African economy during his maiden mid-term budget speech.

GDP growth has been revised downwards from 1.3% to 0.7% in 2017; 1.1% in 2018; and 1.5% in 2019. Unemployment is currently at 27.7%, the highest level since 2003. Gross tax revenue is projected to be R50.8 billion below the target set for 2017/18 and the trend will continue, reaching a projected shortfall of R209 billion by 2019/20. The gross national debt level is now projected to increase to above 60% of GDP by 2022. Debt service costs will be R1 billion higher in 2017/18 and are forecast to increase to 15% of budget revenue by 2020/21. The Minister acknowledged that this dismal state of affairs requires urgent steps by the government to restore confidence in its ability to manage the economy responsibly and to reboot economic growth.

What was expected next from Minister Gigaba was an explanation of the new measures and initiatives government plans to undertake to stimulate growth, restructure the economy and cut already massive government expenditure. However, the Minister missed out on an opportunity to give South Africans hope and to demonstrate to investors how government plans to get South Africa out of this economic crisis, and especially how it plans to curb excessive government expenditure and consumption.

Instead, Minister Gigaba went on to confirm yet another bailout for SAA and the South African Post Office which will be financed through the partial sale of government's stake in Telkom. The sustainability of the country's finances is now in jeopardy - the fact that Treasury has breached the debt ceiling for SAA and the Post Office was enough to compel the Minister to attach stringent bailout conditions and measures to be implemented by them, including bringing on board a strategic partner at SAA. However, it is questionable whether the appointment of new boards in state-owned enterprises (SOEs) is sufficient to address the extent of maladministration and governance failures that have become so abundantly clear.

Chief concerns on the minds of rating agencies for the South African economy are government's commitment to fiscal consolidation and political stability. Against this backdrop it is also concerning that new demands for higher education and public service wage financing will further put pressure on the fiscus.

Gross national debt has reached its highest level since 2008 and the weaker growth outlook reflects a continued deterioration in business and consumer confidence. The consolidated budget deficit for 2017/18 is expected to be 4.3% of GDP, compared with a 2017 Budget estimate of 3.1%. ARC rating agency downgraded South Africa to junk status on 24 October, a day before the mid-term budget. This shows that there was not much Treasury could do to reassure rating agencies at this point.

Although ARC is not one of the big three rating agencies, its downgrade of South Africa to junk signals what is to come from other rating agencies. Moody's is the only agency that still has South Africa on an investment grade, but it will be reviewing the country's credit rating in November 2017. A failure to keep government debt and the fiscal deficit in check spells more trouble for South Africa, which could have its local debt lowered to non-investment grade.

S&P and Fitch cut South Africa's foreign currency debt to junk early this year. At this point, there is not much preventing South Africa from being downgraded to junk status - including the mid-term budget. Nonetheless, some rating agencies, like many South Africans, seem to be waiting for the ANC's December conference where a new leader of the ANC will be elected, and perhaps new policy directives might emerge.

Against this backdrop, the one-line confirmation by Minister Gigaba that the government will go ahead with the controversial nuclear deal at "a pace and scale that the country can afford" rings hollow in the ears of those who were looking for a significant policy shift that recognises the seriousness of South Africa's economic position.

Where does this leave South Africa internationally against its BRICS peers? According to the OECD's June 2017 economic outlook, Brazil's fiscal deficit remains above 9% of GDP, rising public debt is currently at 72% of GDP and its growth outlook for 2017 is 1.6% of GDP and 1.7% of GDP in 2018.

Russia's projected GDP growth is 1.4% and 1.6% for 2017 and 2018 respectively, it maintains a budget deficit of 3.8% of GDP and its total government debt is 17% of GDP. China's fiscal policy remains expansionary with recent tax cuts having been announced to maintain the recovery's momentum, growth has stabilised and projected at 6.6% and 6.4% of GDP for 2017 and 2018 respectively. Its debt is estimated to be in excess of 250% of GDP, but it is also the largest holder globally of foreign reserves in excess of US$3 trillion. India remains the fastest growing G20 economy with projected GDP growth of 7.3% and 7.7% for 2017 and 2018, supporting consumption through increasing public wages and pensions, while maintaining a fiscal deficit of 3.9% and public debt of 67% of GDP. In all the BRICS, SOEs play a significant role in the development trajectory of these countries, but there are several cautionary lessons to be drawn from their experiences.

Perhaps the key focus areas for South Africa, compared to its BRICS peers, should be generating robust growth and building far more efficient SOEs. In this endeavour there is a need for the private sector and government to work together more closely in resolving the current regulatory uncertainty.

There is general consensus that global growth has taken a positive turn with the World Bank projecting that sub-Saharan Africa will grow at 2.6% in 2017 with Kenya and Ethiopia expected to grow at approximately 5% (depending on the outcome of the current election impasse in Kenya) and 8.5% of GDP, respectively. But much of the global recovery is bypassing South Africa. South Africa's justification for the lack of growth over the past two years, namely the global economic slowdown, the commodity price slump and the drought (despite the ongoing challenges in the Western Cape), is now irrefutably debunked.

Minister Gigaba left South Africans, investors and rating agencies still wondering about the future economic trajectory of South Africa. The Rand lost approximately 26 cents during his speech - if there is any doubt that the mid-term budget was unfairly criticised, the market had the final say on the matter!

Palesa Shipalana is the Head of SAIIA's Economic Diplomacy Programme and Neuma Grobbelaar is SAIIA's Research Director.

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