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On Thursday morning, the rand crashed to its weakest level in more than three weeks after an alarming medium-term budget policy statement (MTBPS).
By late morning, it was trading at R15.17/$ – after starting the week at R14.50/$.
The rand started weakening on Tuesday amid disappointment about government's rescue plan for Eskom, which was presented by Minister of Public Enterprises Pravin Gordhan. Gordhan said Finance Minister Tito Mboweni would expand on plans to deal with Eskom's R450bn debt burden.
But Mboweni didn’'t – he only warned that Eskom needs to show that it can cut costs first before he will restructure its debt.
To make things worse, Mboweni's MTBPS showed an alarming deterioration in government finances: there's a projected tax shortfall of R53bn, with the national debt nowtopping R3trn and on track to grow to R4.5trn by 2022 – or 71.3% of the gross domestic product (GDP). There was a massive increase in the budget deficit from 4.3% of GDP to 6.2% - and that's just since February.
The budget statement was certainly honest, said Peter Attard Montalto, head of capital markets research at Intellidex, in a report entitled "MTBPS car crash – into political will wall”.
"But the real focus on the MTBPS must be that (Treasury) attempted to make significant cuts and then ran into a brick wall in the last month, we believe. We are sceptical (of these) changes by February and as such, even though some small tweaks will be offered at that point, which marginally shifts the fiscal profile, we will largely be stuck here," says Montalto.
He says Treasury wanted cuts of up to R200bn.
"We believe there was some moderate initial progress... but the process reached both a practical and political wall. The political wall is that there is no deployment of political capital for cuts as a macro-fiscal concept... But equally we think Cosatu inserted itself to provide strong resistance."
The day after: No worry. We have a plan. Everything’s under control. The Rand? 15.16 to the dollar. pic.twitter.com/6KFmnr7LxD
— David Shapiro (@davidshapiro61) October 31, 2019
Moody's
Montalto said the focus will now shift to how this situation can improve to the February budget.
"Though some tax hikes and some expenditure trimming can be possible, fundamentally we are stuck at roughly this deficit and debt profile, which is alarming."
Most commentators now believe Moody's will, at the very least, downgrade South Africa’s outlook to "negative" from "stable" on Friday. That would be the last step before it downgrades South Africa to junk. Some believe Moody’s could even bypass the outlook downgrade, and go directly to "junk" as early as this week.
Moody's is the only one of the investment rating agencies that still believes SA bonds are investment grade. If SA is "junked" by Moody’s as well, it will cost the country its place in the most important group of government bonds. The Citigroup’s World Government Bond Index contains only bonds that are investment grade.
All the many overseas investment funds that are only allowed to invest in investment grade bonds would be forced to sell their South African government bonds.
This will lowered the value of SA bonds, and make it much more expensive for government to borrow money to keep the country afloat. It may mean higher taxes in future.
Fed cut
The rand's slump came despite the US central bank's decision to cut interest rates for the third time this year last night. The US rate is now between 1.5% to 1.75%, which makes the rand, which offers an interest rate of 6.5%, look more appealing to foreign investors. Brazil also cut its interest rate, to 5%, on Wednesday.
However, Fed Chair Jerome Powell said that further cuts are not planned – unless the economy deteriorates.
