Some Notes on the Word Around Us

  • Charles Snyman

Crossroads and U-turns

A look at the medium term budget speech (MTBS)

The week ending October 26, 18 saw Mr Tito Mboweni delivering his first public appearance as our new Finance Minister. We expect this to be the opening of a new chapter in our beautiful country and think that the equity markets seemed to have responded quite positively. This issue of Some Notes summarizes articles that appeared in the popular press in the ensuing day or two.

Not a crossroad but a wholesale U-turn

In his pre-budget press conference, which he quaintly termed his ‘maiden’ press conference, finance minister Tito Mboweni revealed how much his thinking has changed in the last 12 years – and possibly diverges from traditional ANC thinking. Here are some of his thoughts:

1. We need to move from the notion that everything must be done by the state. I have a problem with this term ‘service delivery. People are sitting at home waiting for me to deliver bread instead of building their own bakeries.

2. We need to move towards partnerships. Let’s bring in private sector experience in project execution. There are engineers and others in the country who are willing to work, you just need to call on them.

3. There also needs to be a reconfiguration of SOEs’. We need to be open to inviting in equity partners, closure of some business activities and restart if needs be.

4. He made specific reference to restructuring at Eskom and SAA. For instance, Swissair was not functioning well, and the Swiss decided to close it down. They invited those who know how to run airlines and start a new airline called Swiss International. We need to be open-minded, the world has changed, it is not static.

5. Referring specifically to the medium-term budget policy statement (MTBPS), which provides clarity on government thinking and budgeting over a three-year period, he mentioned that this new way of thinking – which is the old way of thinking – the focus must be utilising the tax revenue that you have best you can.

6. And this is where the rubber hits the road. Government’s consolidated expenditure is growing at 7.8% a year on average. Real non-interest spending (which excludes debt repayments) is growing at 1.9% a year – just ahead of the population growth rate (1.2%). This is a far cry from SA’s glory days between 2005 and 2009 when non-interest spending was growing at between 7.2% and 10.8% a year.

7. Yes, the budget was in surplus and the world was a different place, but decisions made at the many crossroads SA has faced since then now require a wholesale U-turn when it comes to economic management of SA’s economy and the state institutions. While the global economy is projected to grow at 3.7% next year, SA limps along at 0.7% this year only reaching a projected 2.3% by 2021.8. This makes the focus on growing the economy, while at the same time rooting out corruption and inefficiency, reforming SOE’s, enhancing infrastructure investment and addressing urgent matters in education and health more pressing.

8. The Giyani Water Project is a cesspool of corruption and it is clear that a new delivery and financing model is required to provide water services to communities. He has requested I have the DG of National Treasury to work with the department of Water and Sanitation to ensure that appropriate action is taken against all guilty officials implicated in the Auditor-General’s report.

9. In his annual report, the Auditor-General identified another R27billion of previously undiscovered irregular spending. That is almost equivalent to the revenue shortfall for this year. In the meantime, public debt continues to expand ahead of expectations to 59.6% of GDP in 2023/24, while unemployment and public dissatisfaction remain at stubbornly high levels.

10. There is no doubt in anyone’s mind that no economic stimulus package can be sustained without focusing on corruption and service delivery. Government must stop talking in contradictory terms.

11. There could be a significant “reconfiguration” of National Treasury in the weeks and months to come, if new finance minister Tito Mboweni gets his way.

However, the MTBPS did not add much additional detail on the implementation of the economic reforms, which include:

  • The draft policy direction for licensing high-demand spectrum has been issued. This will be allocated by April next year.

  • Work is underway on restructuring options for the electricity sector. (This must include a long-term plan to restructure Eskom and deal with its debt obligations.)

  • The economic regulation of Transport Bill is before Parliament.

  • The Mining Charter has been approved by Cabinet.

  • Visa regulations are being amended to boost tourism.

In addition to the growth-enhancing economic reforms, the MTBPS expands slightly on four other measures to stimulate the economy. The minister proposed a combination of reprioritisation and changes to grant structures and in-year allocations amounting to more than R50 billion:

  1. Of this R15.9 billion goes towards better-spending infrastructure programmes, clothing and textile incentives, and the Expanded Public Works Programme. As an indication of success, the clothing and textile competitiveness program sector has helped sector exports grow from R7.1 billion in 2008 to R25.1 billion in 2017.

  2. Another R16.5 billion is allocated to various programmes and entities, including funding for SARS, a minimum wage for community health workers, critical posts in health and management of the justice system.

  3. Agriculture will be an important driver of SA’s economic recovery and the Land Bank will remain central. “Our reprioritisation efforts will support the bank to conclude transactions worth R16.2 billion over the next 3 to 5 years that will create jobs in agriculture.”

  4. Government planning around the proposed Infrastructure Fund is advancing in partnership with development finance institutions and private sector partners. Funding is being negotiated from DFI’s, multilateral development banks and private banks. In addition, these institutions have committed technical resources to help plan, approve, manage and implement projects.

While infrastructure funding and development is one lever with which to grow the economy, the government cannot do it alone. This is evidenced by the fact that gross fixed-capital formation (public and private sector investment in physical assets) has declined significantly in recent years. Thus, it is now a government policy objective to promote an increase in fixed capital investment by the private sector.

Policy certainty along with a U-turn on the role that business can play in the economy will go a long way to changing that. Can Mr Mboweni walk his fighting talk?

But it was evident that Mboweni wants to tackle problems decisively. As an example, he cited roping in the army to tackle the pollution problem in the Vaal River system. He also referred to the N3 and N4 highways as examples where the private sector not only built the infrastructure but are also the operators. For such projects to operate efficiently, government has and must have service level agreements in place with private sector partners. These kinds of partnerships will be accelerated.

He also referred to the tomato producer ZZ2 in answering a question on land reform. “We need to partner with them as they know how to grow tomatoes. Rather than take their land, which will be the worst outcome, we need to allow them to help us.”

Mr Mboweni reiterated that such partnerships can play a significant role to improve efficiencies at Eskom (and other of course). Such partnerships are possible, and the private sector will help if asked. We need to look at these options and this must result in actions to which the market will react.” He belaboured the point that private sector involvement will be pivotal, not only for investments of their own, but also to ensure public projects are executed efficiently.

The question now is whether Mboweni, after being in the Treasury hot seat for less than a month, has the authority to implement the changes he proposes. We have seen several Ministers of Finance in recent years making promises of implementing urgent reforms, most of which did not materialise. But Mr Mboweni clearly has the support of President Cyril Ramaphosa.

Hopefully Mboweni is not “corrupted” by party politics. His decisive approach is critically needed to pull our economy back from the precipice.

Has the MTBPS done enough to appease Moody’s?

The current situation in South Africa is summarized as follows:

South Africa’s economy is shrinking, with unemployment at a 14-year high of 27.7% (or 37.2% if the definition of unemployed is expanded to include those too discouraged to look for work).

The South African Reserve Bank (SARB) announced earlier this year that SA is in a technical recession following two consecutive quarters of negative growth. Real GDP growth averaged just 1.6% per annum during 2012–2017, in contrast to the National Development Plan’s goal of economic growth exceeding 5% per annum towards 2030.

In the MTBPS, National Treasury forecasts that GDP growth will slow to 0.7% in 2018, down from 1.3% in 2017, before rising to 1.7% in 2019 and 2.1% in 2020.

The MTBPS articulates a critical aspect of overestimation of GDP in government forecasts over the past six budget cycles. What this means is that weaker growth outcomes have brought about unanticipated revenue shortfalls which go some way towards explaining the increases in government’s debt-to-GDP ratio.

Fiscal policy will remain incredibly challenged in bringing about growth in the medium term. While economists in a Bloomberg survey estimated the budget deficit at 3.8% of GDP in the current fiscal year, the MTPBS states that the main budget deficit is estimated to widen to 4.3% in 2018/19 due to fiscal slippage. This is by far the highest level since 2008.

Despite this bleak outlook, Moody’s Investors Service hosted a relatively upbeat investor conference in September. At that conference, the ratings agency said a change in SA’s rating was unlikely until at least after the national elections in 2019. The credit rating agency even said that SA’s credit rating may be upgraded, depending on certain economic reforms. This is according to a credit opinion from the agency, which importantly does not constitute any rating decision.

The report compiled by Lucie Villa, Moody’s lead analyst for South Africa, states that: “Successful implementation of structural reforms to raise potential growth as well as stabilise and eventually reduce the government’s debt burden, including through reforms to SOEs [state-owned entities] that reduce contingent liabilities, would exert upward pressure on SA’s ratings.”

Here at home the political, economic, state capture and emotional temperature fluctuates with wide swings daily, caused by several factors. The announcement of a recession should not have come as a surprise. Declines in employment, business confidence, agricultural and manufacturing output and industrial production, as well as falling retail and vehicle sales over the last few quarters, was a clear indication that all was not well.

The poor financial position of SOEs has resulted in government’s guarantee portfolio totaling R670 billion. Given that these entities will find it difficult to refinance maturing debt as investors increasingly require guarantees before they will provide financing, government’s contingent liability exposure is likely to remain high. The state’s exposure increased to 64.5% in the past fiscal year from 54.4% as companies drew on the guarantees.

The MTBPS contained little evidence of structural reforms, with additional bailouts promised to various state entities, including R8billion of additional funding to SAA and the South African Post Office (R5billion and R2.9billion respectively)

The ever-growing public sector bill also remains a major concern.

Last year the MTBPS was a red flag for SA’s credit rating with Moody’s expressing concern shortly thereafter that SA’s interest payments ratio exceeded the median of its peer ratings group. According to Moody’s, more than a third of all sovereign defaults occur when countries allow fiscal imbalances to persist, resulting in unsustainably high debt burdens. When they are no longer able to service or reduce their debt, downgrades invariably follow.

The MTBPS expects gross loan debt to increase to 55.8% of GDP in 2018/19, mainly to finance the budget deficit. The weaker rand accounts for about 70% of the R47.6 billion upward revision to gross loan debt in the current year. Debt is expected to stabilise at 59.6% of GDP in 2023/24 – at a higher level and a year later than projected in the 2018 Budget.

An estimated 15.1% of main budget revenue will be used to service debt in 2021/22 compared with 13.9% in 2018/19. The cost of servicing debt is the third-fastest growing expense in the budget.

Moody’s is expected to release its statement on South Africa’s sovereign credit rating now that finance minister Tito Mboweni has delivered the medium-term budget policy statement (MTBPS). Despite several pieces of bad news contained in this year’s statement, it is hopeful that Moody’s will not revise its current rating downwards. The strong intentions expressed by government notwithstanding, the current statistics remain hard to ignore.

Moody’s is the last of the three major credit rating agencies to keep SA’s credit rating at investment grade level. S&P and Fitch both downgraded SA to junk status last year, in response to the surprise cabinet reshuffle and an unfavourable mid-term budget in October 2017. Moody’s downgraded SA’s sovereign ratings to the cusp of junk in June 2017, warning that the country could lose its investment-grade rating if its economic and fiscal strength continued to falter. A further credit rating downgrade by Moody’s would therefore take its credit rating on South African bonds also down to junk status.

A downgrade to sub-investment grade would see SA expelled from the Citi World Government Bond Index, prompting asset managers and pension funds to sell domestic bonds. This would sharply increase the cost of debt and put further pressure on the exchange rate.

The 2018 MTBPS claims that government will maintain its spending ceiling as well as national departments’ compensation ceilings. Fiscal policy and the debt management strategy will work to mitigate risks to fiscal projections. We can only hope that the medium-term budget is enough to indicate to credit ratings agencies that, on his watch and in sync with President Ramaphosa, the buck finally may stop here.


© 2018 by FAL Invest (Pty) Ltd.

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