Budget 2023
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Ratings under threat

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Finance Minister Malusi Gigaba’s budget speech this week will most likely not reverse the country’s credit rating downgrade trend, which has been persistently worsening over the past six years.

A much greater uptick in economic growth is vital if the trend is to turn around.

However, Gigaba’s steps to reduce the debt-to-GDP ratio and the budget deficit in the years ahead from what was forecast in October, through tax hikes and expenditure cuts, might cause Moody’s Investors Service to hold off on downgrading the country to “junk” status next month.

Fitch Ratings and S&P Global cut South Africa to junk status in April.

If Moody’s downgraded South Africa, there could be tens of billions of rands in capital outflows, which would weaken the rand, push up interest rates and possibly knock the country into recession.

South Africa’s downward trend started in November 2011, when Moody’s put the country’s investment grade credit rating on a negative outlook. Then, in September 2012, Moody’s was the first of the major ratings agencies to start downgrading the country after a series of upgrades starting in 1995.

Gigaba is forecasting growth of 1.5% this year, 1.8% next year and 2.1% in 2020.

Kamilla Kaplan, an Investec economist, this week said: “The efforts of the moderate fiscal consolidation outlined in the 2018 budget are likely to be deemed as sufficient to avert a Moody’s downgrade.

“However, averting further credit rating downgrades over the longer term will require a sustained economic growth recovery to 3% and beyond.”

On the other hand, Gigaba said he believed he had done enough to head off further downgrades. “We have taken the tough decisions,” he added.

FNB economists Mamello Matikinca and Jason Muscat said: “The budget has put government finances back on a trajectory that attempts to consolidate the fiscal position over the next few years. We believe it will be enough to delay a downgrade by Moody’s next month.

“However, we are concerned by the drastic shift in expenditure, which now leans more to consumption rather than capital expenditure. If maintained, government could potentially be setting itself up for further downgrades down the line. Furthermore, very little detail about structural reform was evident ... With an increased tax burden, it is vital that reforms that lift growth meaningfully are hastily implemented.”

Rob Johnson, head of Investments at Nedgroup Investments, said he thought the steps outlined in the budget speech would not be enough to convince ratings agencies not to downgrade South Africa.

“I don’t believe that the budget does enough on its own to stave off a credit downgrade. There are some green shoots of hope in the upgrade of GDP projections, the strength of the government to increase VAT in the face of criticism from the tripartite alliance and the desire shown to curb spending.

However, the country faces many challenges – some of which are not controllable, such as the affect of weather on agriculture and the sustainability of global growth – to maintain a path towards improving economic, institutional and fiscal trends,” Johnson said.

“Having said that, the combination of a budget in the right direction and a new political direction under President Cyril Ramaphosa may actually accelerate an improvement in the budget deficit, which has a good chance of persuading Moody’s to give the country more time before instigating a downgrade.”

George Glynos, the managing director at ETM Analytics, said that the budget speech “guaranteed” a downgrade by Moody’s.

“The downgrade won’t necessarily come through in March, but possibly later this year.”

Gigaba’s budget is forecasting that the debt-to-GDP ratio will rise to 53.3% – the highest level for this measure in at least 30 years – by the end of March next year.

In October, Treasury forecast the debt-to-GDP ratio would climb to 54.2% by March next year. This measure is expected to peak at 56.2% in the 2023 tax year.

Glynos said that the expenditure side of the budget speech was unrealistic, and higher spending could result in an above forecast rise in state debt and the debt-to-GDP ratio, which would increase pressure on the credit rating.

He said that Treasury hadn’t budgeted for any possible bailouts of state-owned enterprises or free tertiary education spend, which could be underbudgeted for as expenditure was based on an estimate rather than being properly calculated through a study.

Fitch Ratings on Friday said that the cost of free tertiary education could rise as the “impact of student numbers is highly uncertain”.

Fitch raised the concern that Gigaba’s fiscal targets faced “substantial risks” from state-owned enterprises, particularly Eskom.

The budget speech forecast that public sector wages would rise by 7.3% over the next three years compared with the average public sector wage settlement from the 2011 tax year to the 2018 tax year of 8.5%.

“The public sector wage negotiations ... could put pressure on expenditure,” Fitch said.

Glynos said that, instead of cutting operational expenditure such as wages, government had instead reduced infrastructure spending, which was key for long-term growth.

“The public sector is bloated and a 7.3% forecast hike in wages compared with inflation of 4.4% ... so a real increase in wages of almost 3%. It is a really poor budget,” Glynos said.

Fitch said: “The planned introduction of the National Health Insurance system also presents ... fiscal risks.”

The budget speech outlines ambitious targets including a 10.1% revenue hike for the 2019 tax year.

The last time government achieved a hike in revenue of the order of 10% was in the 2014 tax year and, since then, the ability of the SA Revenue Service (Sars) to collect tax has decreased.

FNB’s Muscat said it was going to be challenging for Sars to hike revenues by 10.1%, but it was “possible”.

In the 2019 tax year, it was expected that fixed investment would improve, that economic growth would pick up, that households would increase spending and that the 1 percentage point rise in the rate of value-added tax would aid collection.

It was important for Sars to be more efficient, and the level of tax compliance must be improved for the 2019 target to be achieved, Muscat said.

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