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LOOKS GOOD ONLY ON PAPER
Alwyn van der Merwe
Director of Investments
Mar 04, 2020
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:
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.
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:
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.
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.
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