The Main Budget revenue collection was R99.6 billion better in 2020/21 (relative to the 2020 Medium-Term Budget Policy Statement, or MTBPS, projection) and is expected to beat previous projections by a further R196.4 billion (cumulative) over the next three years. This development has translated into a smaller-than-expected budget deficit of 12.3% of gross domestic product (GDP) in 2020/21 (relative to the 2020 MTBPS projection of 14.6% of GDP) and improved projections for the budget balance over the medium term.
Treasury has also employed an appropriate strategy to address South Africa’s fiscal problems by restraining consumption expenditure, growing capital expenditure faster than other spending categories, and raising indirect taxes (mitigated by compensating for fiscal drag), while refraining from increasing income taxes further. The latter are a disincentive to saving and investment. Indeed, Treasury signalled a cut in the corporate tax rate to 27% for companies with years of assessment starting on or after 1 April 2022.
In the 2020 MTBPS, the Main Budget primary balance (revenue less non-interest spending) was projected to decrease to -1.4% of GDP by 2023/24. The February 2021 Budget shows a decline in this deficit to -0.8% of GDP over the same period.
The projected expenditure restraint is material. For example, real consolidated non-interest spending declines by an average -0.8% per year over the next three years. In turn, expenditure discipline, critically, hinges on constraining the increase in the consolidated government wage bill to average annual increases of just 1.2% in current prices over the medium term. However, this is onerous, implying execution risk is material.
INCREASING DEBT RATIO
Despite the right intent from Treasury, the fiscal challenges remain daunting. Treasury projects that the gross loan debt ratio will stabilise at 88.9% of GDP in 2025/26, before declining. The revised debt trajectory is significantly flatter than its previous forecast, which showed the debt ratio increasing to 95.3% over the same period. But the point is that the debt ratio is already excessive and it continues to increase over the next five years.
In any event, the improvement in the primary balance is not sufficient to stabilise the debt ratio. Given the current gap between the effective real interest on debt and the trend real growth rate of the economy, a primary balance surplus of close to 2% of GDP is required to steady the ship. That is a large swing from an expected primary balance deficit of -4.0% of GDP in 2021/22.
The increase in gross loan debt is a function of the budget deficit, the discount on loan transactions, revaluation of inflation-linked bonds, revaluation of foreign currency debt, and the change in cash and other balances. At the end of March 2021, the government’s cash balances are expected to amount to R294.6 billion, which is lower than the R378.4 billion recorded at the end of January 2021, but still large. A decline in cash balances of R107.876 billion, along with a decline in other balances of R4.724 billion, helps fund the government’s gross borrowing requirement of R547.9 billion in 2021/22. Accordingly, issuance of domestic long-term loans falls to R380.0 billion in 2021/22 from R518.5 billion in 2020/21, while issuance of short-term loans falls to R9.0 billion from R97.2 billion.
That said, even though the government’s borrowing requirement is expected to decline over the next three years, it remains large. In 2020/21, including loan redemptions, the gross borrowing requirement amounted to R670.3 billion (13.6% of GDP). And, although the Main Budget balance is projected to decline to R389 billion (6.5% of GDP) in 2023/24, redemptions increase to R152.7 billion from R66.9 billion in 2020/21, leaving a gross borrowing requirement of R541.7 billion (9% of GDP) in 2023/24. Hence, the government continues to absorb a large share of domestic savings, which will continue to constrain the ability of the private sector to invest – unless foreign capital inflows are sustained at a high level.
The negative debt dynamics at work are clearly illustrated by the budgeted increase in debt servicing cost from 4.7% of GDP in 2020/21 to 5.6% in 2023/24, or from 19.4% of Main Budget revenue in 2020/21 to 22.2% in 2023/24. This leaves fewer resources for development.
CONTINGENT LIABILITIES
Meanwhile, there’s also the issue of large contingent liabilities due to government guarantees on the debt of state-owned companies. These guarantees are expected to amount to R581 billion at the end of March 2021, with an exposure of R410.3 billion. Eskom accounts for 77.2% of the latter. In addition, medium-term debt redemptions of state-owned companies are large, amounting to a total of R182.8 billion.
Ultimately, although there is some progress, the scale of the improvement required in the primary budget balance to stabilise the debt ratio, against the backdrop of low potential economic growth, high real borrowing costs and deterioration in the state’s balance sheet, implies the risk associated with South Africa’s fiscal policy remains high.
Commentary by Alwyn van der Merwe, Director of Investments:
When our Finance Minister delivered his MTBPS in October last year, it was clear that South Africa was heading down the slippery slope leading to fiscal disaster. The Minister then reflected honestly on South Africa’s fiscal realities, which were looking decidedly ominous. However, given the strong performance of commodity prices in the second half of 2020, company tax revenue exceeded expectations materially (by R99.6 billion) and, as explained by Arthur above, provided a proverbial ‘get out of jail free’ card to the Minister.
As a result, most of the key fiscal ratios printed materially better compared to the 2020 MTBPS. Although it shouldn’t have been a major surprise for analysts, we now have confirmation of the lower-than-initial deficit ratio, the debt-to-GDP trajectory looks less daunting on paper, and as a result, the financial needs of the government have moderated somewhat.
The bottom line is that the fiscal snapshot and outlook have improved, and financial markets should respond positively. The lower funding requirement simply means that we should witness lower bond auctions or supply of government bonds than initially envisaged, including foreign funding.
Having said this, we would be surprised to see a material immediate strengthening in bond prices, as the longer-term doubts regarding the government commitment to fiscal consolidation against a background of slow economic growth and the funding requirements of dysfunctional state-owned enterprises won’t disappear soon. Visible growth reforms are needed to augment the constructive fiscal steps to ensure debt stabilisation.
Investors in so-called SA Inc shares – shares generating their profits predominantly in SA, such as banks, retailers and local industrial counters – should in the main welcome the 2021 Budget. There is no net change in the tax burden, nor are there further spending reductions. The company tax rate has also been reduced to 27% from the 2022 financial year. To put it bluntly, there were no material negative surprises. In the final analysis, however, we doubt that the Budget will be the most dominant factor driving equity prices in 2021.
