After the Medium-Term Budget Policy Statement (MTBPS) in October last year, we argued that our Finance Minister had to present the statement in an economic and political environment fraught with challenges. Last week’s Budget Speech was no different. Fiscal trends were all pointing in the wrong direction, and this had to be addressed if the Minister was to be seen as being truly dedicated to ultimately stabilising government debt levels in 2023/24.
In the run-up to the Budget Speech, analysts speculated whether Minister Mboweni would have the fortitude to address the obvious overspending on government consumption to reduce expenditure in relation to gross domestic product (GDP), as his options to generate increased revenue were rather limited in an environment in which economic growth is not exactly positive in real terms.
Although numbers weren’t unimportant for this Budget, it was clear that ‘the market’ wanted the Minister to show signs that he would address these issues:
- A slowdown in the rate of government consumption expenditure
- An acknowledgement that continued tax increases have become counterproductive
- A clear intent to reduce the primary budget deficit – the deficit before accounting for interest payments – against the background of an ever-escalating interest bill eroding spending power in other essential areas
- Fiscal consolidation that will reduce the gross debt burden, expressed as a percentage of GDP.
Major wage bill cut
The focus of Minister Mboweni’s proposed spending restraint, which decreases budget non-interest spending by R156.1 billion over the next three years, is a R160.2 billion decrease in the government’s wage bill. Treasury believes this reduction will be achieved through a combination of changes to cost-of-living adjustments, pay progression and other benefits. If successful, these changes will see the consolidated wage bill shrink by 1% in real terms over the medium term. This follows a period in which the wage bill has grown by around 40% over the past 12 years, crowding out capital expenditure and spending on other projects crucial for service delivery.
Given the struggling economy and the already elevated tax-to-GDP ratio (an estimated 26.3% in 2020/21), Treasury made the surprising decision not to raise additional revenue from taxes in 2020/21. The adjustment to personal income tax reflects a higher-than-inflation increase in brackets and rebates that will ‘cost’ the fiscus a net R2 billion. The focus will instead be on rebuilding capacity at the South African Revenue Service (SARS) and restoring the public’s trust in this institution.
The primary budget deficit – the deficit before allowing for interest payments – of -2.6% of GDP for 2019/20 is projected to decrease to -1.1% of GDP by 2022/23. This is indeed a movement in the right direction. However, it still falls short of the surplus of at least 1% of GDP required to stabilise the debt ratio.
Unfortunately, despite the positive signs mentioned above, the net result doesn’t lead to an improved gross debt-to-GDP ratio. In fact, the debt trajectory mapped out in Budget 2020 sees gross loan debt increase to 65.6% of GDP in 2020/21 from 61.6% in 2019/20, and then increase to 69.1% in 2021/22 and 71.6% in 2022/23. This estimate is roughly in line with the projections captured in the MTPBS in October 2019.
Judging by the response in the currency, the bond market and rand-sensitive equities, ‘the market’ decided to focus on the positive signs. The fact that the debt ratio has not been projected to deteriorate much further was also seen in a positive light.
Only on paper
Although we applaud the Minister’s political bravery to address the important issues, we believe it would be naïve not to note that although the Budget Speech reflects intent, it’s unfortunately only on paper. In recent years – admittedly under different leadership – we’ve consistently witnessed the government falling woefully short – for various reasons – in executing its plans.
We see risks in three areas:
- The constraint on government consumption expenditure does rely heavily on the ability to negotiate the necessary wage restraint, which suggests forecast risk. In addition, the budget non-interest spending cuts are largely back-ended with a net decrease of R8.8 billion in 2020/21, followed by net cuts of R60.9 billion in 2021/22 and R86.5 billion in 2022/23.
- The budget deficit remains wide and the debt ratio continues to increase over the next three years. The main budget deficit of 6.5% of GDP in 2019/20 was the highest number in nearly three decades and came after a period during which global economic activity recovered consistently since 2010. This was way off the mark compared to the initial budget deficit of 4.7% of GDP published in February 2019. This reflects a revenue shortfall of R63.3 billion, as well as increased support for state-owned enterprises (SOEs) – mainly Eskom. The deficit remains wide at 6.8% and 6.4% of GDP in the next two fiscal years respectively.
- As mentioned, the debt ratio continues to increase over the years ahead, reflecting the extent to which South Africa’s fiscal trajectory has deteriorated amid high expenditure levels and an inability to protect the balance sheet of the state. This is clearly reflected in the ongoing drag from ailing SOEs.
There is, however, little doubt that the narrative of the Budget Speech suggests that the government is prepared to initiate the first steps to address a fiscal dilemma that will take a number of years to solve – provided it stays the course.
More than a fiscal plan
This Budget Speech was more than just a fiscal plan. South Africans and the world wanted confirmation as to whether the government was prepared to put a plan together that might not be popular with its traditional alliance partners, but would put our economy on a better footing. There were certainly signs that the willingness is there. Whether this will be enough to address the fiscal and economic growth concerns of rating agency Moody’s remains to be seen.
The bond market responded positively as the bellwether government bond, R186, strengthened by 10 basis points after the Minister’s speech. The funding needs for the current fiscal year didn’t change materially. To expect sustained strength in bond prices would surprise us given the forecast risk of longer-term funding and South Africa’s current economic realities.
Local equity investors were delighted. We saw significant share price increases in the banking and local retail sectors. We’ve argued for a while that these shares are cheap, and we have in recent months cautiously increased exposure to these two sectors in our client portfolios, based purely on valuation principles. Again, we did not identify a National Budget as a potential trigger for increased buying interest in these two sectors. Our view has been that low expectations in terms of financial performance would ultimately support the prices of these arguably cheap shares. We hope this step in the right direction will be the first in a longer journey that will ultimately unlock value in these shares.