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THE budget has to deal with one big question – what is done about the implications of such a weak rand (high infrastructure and debt service costs)?
The answer, however, is likely to be within the broader framework of an ongoing departmental spending freeze, good revenue performance into December, and under spend – basically continuation of the ‘boring and conservative’ macro line.
As a result there will be, in our view, an implicit slowdown in pace of investment spending within the budget, although some can probably be offset through efficiency savings etc.
We think there is unlikely to be any major announcements or tax changes given where we are before the election, with the exception probably of a few small political give-aways that won’t be significant in the top down picture.
Given this, rating agencies are likely to be cautiously constructive on the outcome, although we still think downgrades could happen post election towards the end of the year. The outcome should also be marginally constructive for the bond market.
Last year's budget highlighted the conundrum of the SA fiscus – seemingly stable on the surface, but a lack of momentum around medium run consolidation beneath that couples with downside tail risks.
That fact remains unchanged; however, revenue performance surprised to the upside into December given a quieter strike season than expected, which means difficult choices are less difficult this time before the election.
This revenue performance will combine with the usual rate of under-spend, budget reserve buffers and higher nominal growth numbers and will result in likely shifts up to national treasury GDP deflator assumptions that as inflation rises that partly offset revisions down to real GDP – to mean there will be a small amount of money to play with. It may amount to around R15bn.
Part of this will be given away in small pre-election political 'treats' – education and jobs likely being the focus, but small fry which would make no difference really to the macro top-down budget view. The key use of this gap will be on higher infrastructure costs as a result of the weaker rand.
Now it's important to remember that the SA infrastructure programme is roughly split 50:50 between government (central, provincial and municipal) and the public sector, with R140bn being for the former and R131bn the latter (before currency adjustments), for the coming year.
The public sector programme is much more import reliant than the government programme, however, so we are talking probably around a R5bn odd increase in costs per year as a result of the 20% fall in rand since the budget last year. However, we do not think the government will bail out such cost increases based on our previous discussions with both national treasury and parastatals.
The budget, in our view, will instead direct a smaller amount of money to cover the costs for the increased costs for the government infrastructure programme. Add to that another R1.2bn in FX debt coupon payments and for the coming fiscal year and another R1.8bn in principal payments of FX debt.
However, we can see that all this does fit into the existing budget framework without upset. The implication of not supporting the wider public sector, however, will be a slower build pace and possibly a small attempt at increased public sector bond issuance, which together will not be growth positive.
The message, therefore, will be to reinforce the existing slow, capacity constrained infrastructure build pace – the spend, of course, is huge, but its growth will be zero basically because of both financial and capacity/skills constraints.
More broadly, we expect very little to occur on the tax front. Some expect there to be some preliminary results from the Davis tax review, but given this is likely to point to the need for a broadening of the revenue base and the inability for this to occur before the election, we think it's unlikely we will get anything meaningful on this front.
No changes are expected to taxes except usual inflation adjustments on the personal side and not on the corporate side to allow for revenue creep. Recent increases to social grants will be highlighted, but we don't think there is room at this budget to be offering anything new on this front at this time despite the election – we think major changes on this front will only come after the election when we have tax increases. The usual sin tax increases are expected.
We think it's unlikely there will be any major announcements on NHI except to see more health-related spending brought under the NHI banner. The funding rapper cannot be brought in at this time given it will most likely involve higher VAT and other taxes.
We expect the expenditure cap to remain in place for departments and still overly optimistic assumptions on public wages to be included given the increase in inflation (and over optimism on implicit real wage increases that will be offered too).
This will help to maintain some wiggle room. We expect no change to the SA Reserve Bank mandate and changes to capital controls are less likely at this time given the volatility in rand.
The politics
President Jacob Zuma's State of the Nation address disappointed investors with the lack of forward looking, positive vision for the economy. We think Finance Minister Pravin Gordhan will try and highlight the achievements of the ANC in government certainly, but also with a more positive forward-looking vision, cognisant of both the rating agencies and investors watching in this current fragile market environment for vulnerable emerging markets like SA.
The NDP will be front and centre and spending priorities highlighted along those lines. The youth wage subsidy too will be trumpeted now that it is finally coming into force – a national treasury policy initiative.
We don't expect any more on more interventionist, leftist, manifesto or Mangaung resolutions issues like support for state involvement in certain sectors such as mining and pharma.
These factors will need to be watched after the election, but not now. We expect the budget to continue to support involvement in the economy only through state development institutions like the development bank and IDC.
The numbers
We believe that GDP will be revised down from 3.0% for this year and 3.2% for next year by around 0.2–0.3 percentage points to take into account of both lower global growth and the sluggish recovery in SA.
CPI for this year should be revised up by around 0.5 percentage points for this year and next year to be much closer to 6% with similar revisions to the GDP deflator that will allow headline deficit to GDP numbers to remain constrained even if there is slight slippage in the nominals.
We think, given the factors we outline above, the deficit profile that is announced for this year and next can remain broadly in line with the mini budget. For future years, however, we think there is still too much optimism on growth numbers and expenditure constraint (particularly on wages).
As such, we still see a much more gradual deficit reduction profile occurring. We think the debt forecast profiles should increase further based on the currency weakness, but we don't believe the underlying (ex currency) moves will be big.
Market implications
There is already set to be a R15.5bn increase in funding requirement in the coming fiscal year anyway – which the market should have priced in broadly. The trouble is that this translated into even reduced long-term local debt issuance given cash draw down of some R20.5bn the mini budget foresaw.
We think this kind of cash draw down may not be wise during the current market environment and that the NT will realise this.
As such, even though the headline funding requirement may be broadly unchanged, we expect local long-term issuance to increase somewhat further. Overall, given market reactions have been somewhat muted to issuance changes and focused more on the headline numbers; this means the budget should be marginally positive for sentiment in the bond market at present.
The lack of electoral spending and the ability to deal with the rand issue should be seen positively – reinforced by likely cautiously supportive rhetoric from the rating agencies.
However, given the ability to do anything in this budget is so constrained both by the politics and the markets – and the continual presence of the fundamental conundrum in the budget – we think true measure of the fiscal situation will only really be possible at any post-election budget that may be brought or the mini budget in October. And that is when we see the risk of downgrade.
- Fin24
*Peter Attard Montalto is a director and emerging markets economist at Nomura.
The answer, however, is likely to be within the broader framework of an ongoing departmental spending freeze, good revenue performance into December, and under spend – basically continuation of the ‘boring and conservative’ macro line.
As a result there will be, in our view, an implicit slowdown in pace of investment spending within the budget, although some can probably be offset through efficiency savings etc.
We think there is unlikely to be any major announcements or tax changes given where we are before the election, with the exception probably of a few small political give-aways that won’t be significant in the top down picture.
Given this, rating agencies are likely to be cautiously constructive on the outcome, although we still think downgrades could happen post election towards the end of the year. The outcome should also be marginally constructive for the bond market.
Last year's budget highlighted the conundrum of the SA fiscus – seemingly stable on the surface, but a lack of momentum around medium run consolidation beneath that couples with downside tail risks.
That fact remains unchanged; however, revenue performance surprised to the upside into December given a quieter strike season than expected, which means difficult choices are less difficult this time before the election.
This revenue performance will combine with the usual rate of under-spend, budget reserve buffers and higher nominal growth numbers and will result in likely shifts up to national treasury GDP deflator assumptions that as inflation rises that partly offset revisions down to real GDP – to mean there will be a small amount of money to play with. It may amount to around R15bn.
Part of this will be given away in small pre-election political 'treats' – education and jobs likely being the focus, but small fry which would make no difference really to the macro top-down budget view. The key use of this gap will be on higher infrastructure costs as a result of the weaker rand.
Now it's important to remember that the SA infrastructure programme is roughly split 50:50 between government (central, provincial and municipal) and the public sector, with R140bn being for the former and R131bn the latter (before currency adjustments), for the coming year.
The public sector programme is much more import reliant than the government programme, however, so we are talking probably around a R5bn odd increase in costs per year as a result of the 20% fall in rand since the budget last year. However, we do not think the government will bail out such cost increases based on our previous discussions with both national treasury and parastatals.
The budget, in our view, will instead direct a smaller amount of money to cover the costs for the increased costs for the government infrastructure programme. Add to that another R1.2bn in FX debt coupon payments and for the coming fiscal year and another R1.8bn in principal payments of FX debt.
However, we can see that all this does fit into the existing budget framework without upset. The implication of not supporting the wider public sector, however, will be a slower build pace and possibly a small attempt at increased public sector bond issuance, which together will not be growth positive.
The message, therefore, will be to reinforce the existing slow, capacity constrained infrastructure build pace – the spend, of course, is huge, but its growth will be zero basically because of both financial and capacity/skills constraints.
More broadly, we expect very little to occur on the tax front. Some expect there to be some preliminary results from the Davis tax review, but given this is likely to point to the need for a broadening of the revenue base and the inability for this to occur before the election, we think it's unlikely we will get anything meaningful on this front.
No changes are expected to taxes except usual inflation adjustments on the personal side and not on the corporate side to allow for revenue creep. Recent increases to social grants will be highlighted, but we don't think there is room at this budget to be offering anything new on this front at this time despite the election – we think major changes on this front will only come after the election when we have tax increases. The usual sin tax increases are expected.
We think it's unlikely there will be any major announcements on NHI except to see more health-related spending brought under the NHI banner. The funding rapper cannot be brought in at this time given it will most likely involve higher VAT and other taxes.
We expect the expenditure cap to remain in place for departments and still overly optimistic assumptions on public wages to be included given the increase in inflation (and over optimism on implicit real wage increases that will be offered too).
This will help to maintain some wiggle room. We expect no change to the SA Reserve Bank mandate and changes to capital controls are less likely at this time given the volatility in rand.
The politics
President Jacob Zuma's State of the Nation address disappointed investors with the lack of forward looking, positive vision for the economy. We think Finance Minister Pravin Gordhan will try and highlight the achievements of the ANC in government certainly, but also with a more positive forward-looking vision, cognisant of both the rating agencies and investors watching in this current fragile market environment for vulnerable emerging markets like SA.
The NDP will be front and centre and spending priorities highlighted along those lines. The youth wage subsidy too will be trumpeted now that it is finally coming into force – a national treasury policy initiative.
We don't expect any more on more interventionist, leftist, manifesto or Mangaung resolutions issues like support for state involvement in certain sectors such as mining and pharma.
These factors will need to be watched after the election, but not now. We expect the budget to continue to support involvement in the economy only through state development institutions like the development bank and IDC.
The numbers
We believe that GDP will be revised down from 3.0% for this year and 3.2% for next year by around 0.2–0.3 percentage points to take into account of both lower global growth and the sluggish recovery in SA.
CPI for this year should be revised up by around 0.5 percentage points for this year and next year to be much closer to 6% with similar revisions to the GDP deflator that will allow headline deficit to GDP numbers to remain constrained even if there is slight slippage in the nominals.
We think, given the factors we outline above, the deficit profile that is announced for this year and next can remain broadly in line with the mini budget. For future years, however, we think there is still too much optimism on growth numbers and expenditure constraint (particularly on wages).
As such, we still see a much more gradual deficit reduction profile occurring. We think the debt forecast profiles should increase further based on the currency weakness, but we don't believe the underlying (ex currency) moves will be big.
Market implications
There is already set to be a R15.5bn increase in funding requirement in the coming fiscal year anyway – which the market should have priced in broadly. The trouble is that this translated into even reduced long-term local debt issuance given cash draw down of some R20.5bn the mini budget foresaw.
We think this kind of cash draw down may not be wise during the current market environment and that the NT will realise this.
As such, even though the headline funding requirement may be broadly unchanged, we expect local long-term issuance to increase somewhat further. Overall, given market reactions have been somewhat muted to issuance changes and focused more on the headline numbers; this means the budget should be marginally positive for sentiment in the bond market at present.
The lack of electoral spending and the ability to deal with the rand issue should be seen positively – reinforced by likely cautiously supportive rhetoric from the rating agencies.
However, given the ability to do anything in this budget is so constrained both by the politics and the markets – and the continual presence of the fundamental conundrum in the budget – we think true measure of the fiscal situation will only really be possible at any post-election budget that may be brought or the mini budget in October. And that is when we see the risk of downgrade.
- Fin24
*Peter Attard Montalto is a director and emerging markets economist at Nomura.
