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MINI BUDGET: WEAK BALANCE SHEET
STILL A CONCERN
In a world where investors are paying close attention to fiscal sustainability, analysts in the main welcomed the improving fiscal policy track record and good intent reflected in Finance Minister Enoch Godongwana’s second Medium-Term Budget Policy Statement (MTBPS) last week. However, the state’s fragile balance sheet remains a cause for concern.
The MTBPS shows an improving fiscal policy track record and good intent. The latter is illustrated by a projected improvement in the primary budget balance (revenue less non-interest spending) from a small deficit in 2022/23 to a significant surplus over the medium term, accompanied by a decline in the gross loan debt ratio.
The problem is the weakness of the state’s balance sheet, which continues to act as a drain on the resources of the central government. Additional funds are being allocated in the current fiscal year (in the form of a special appropriation of R30 billion) in an attempt to mitigate the risks posed by SANRAL, Transnet and Denel. Treasury also noted that the Land Bank remains in ‘financial distress’.
Moreover, Treasury indicated it expects to take over a portion of Eskom’s debt, which implies the debt trajectory sketched by Treasury is likely to be altered. From one perspective, it is imperative that the government stabilises the financial position of Eskom. That said, this development is an illustration of the continued large drain of state-owned enterprises on the resources of the state.
Given an expected revenue overrun of R83.5 billion in 2022/23, the Main Budget deficit is expected at -4.9% of gross domestic product (GDP) in the current fiscal year, relative to the initial estimate of -6.0% of GDP published in February 2022. Over the medium term, the deficit narrows more sharply than previously expected, to reach -3.3% of GDP by 2025/26.
At the same time, the gross loan debt ratio falls from 71.4% of GDP in 2022/23 to 70.0% of GDP in 2025/26, reflecting an improvement in the primary budget balance from a deficit of -0.2% of GDP in 2022/23 to a surplus of +1.5% of GDP in 2025/26.
This allows for a significantly lower funding requirement in 2022/23 of R411.2 billion, which is markedly lower than the initial February 2022 estimate of R484.5 billion. This includes R299.4 billion in domestic long-term debt issuance, compared to the initial estimate of R330.4 billion.
At the same time, the government expects net foreign funding to amount to R73.8 billion, which is higher than the initial estimate of R47.88 billion. Treasury still expects to supplement these funding measures by running down cash and other balances by R41.4 billion (although this is less than the previous projection of R106.2 billion).
Expected total funding is also lower in 2023/24 at R446.7 billion, relative to the previous estimate of R487.6 billion. However, this number is still high and the government’s demands on available savings in South Africa continue to crimp private sector borrowing and investment, against the backdrop of tighter global financial conditions, insufficient foreign capital inflows and a higher cost of funding.
The projected path for the Main Budget deficit and the government debt ratio over the medium term relies on upward revisions to revenue of R94.6 billion in 2023/24 and R99.7 billion in 2024/25, seemingly reflecting the lingering impact of the commodity boom and improved tax administration.
This does not seem unreasonable, although the extent of the upward revisions may be challenged, considering the risk of lower-than-expected global and domestic economic activity levels.
Moreover, the decrease in the debt ratio is modest over the medium term, whereas significant fiscal space should ideally be created. South Africa cannot rely on an extended period of economic expansion, given the uncertain, volatile global economic backdrop. Considering this, it would have been preferable if the spending ceiling had been maintained.
A significant portion of the upward revisions to revenue is, however, spent. It is right to maintain the social relief of distress grant for another year beyond the current fiscal year. Indeed, there is a strong argument to retain it until such time as growth lifts, unemployment falls and living standards improve. Nonetheless, the upward revisions to Main Budget non-interest spending are significant, including a net increase of R37 billion in 2022/23, R52.4 billion in 2023/24 and R58.5 billion in 2024/25.
Notably, consolidated expenditure on government employee compensation increases to R693.1 billion in 2022/23 relative to the estimate of R682.5 billion published in February 2022. In addition, compensation amounts to R699.8 billion and R729.6 billion in 2023/24 and 2024/25 respectively, which is higher than the previous February 2022 projections of R675 billion and R702 billion for these two fiscal years.
It was important to show an improved track record and good intent in the MTBPS, given South Africa’s current macroeconomic backdrop in a world where investors are paying close attention to fiscal sustainability.
However, fiscal consolidation is about more than just the government budget deficit and debt ratios. An important indicator of successful fiscal consolidation is an improving balance sheet. Tracking the change in the difference between the capital stock of government and its liabilities (net of cash balances) is one method by which we can judge the health of the state’s balance sheet. This ratio has deteriorated sharply for general government, from more than +25% of GDP in 2007 to around -12% of GDP in 2021.
Although the government’s fixed assets have increased relative to GDP during this period, the improvement is modest and it has been accompanied by a surge in debt, in turn reflecting fiscal transfers to support ailing state-owned companies and excessive government consumption spending. South Africa’s fiscal position therefore remains far from comfortable.
Commentary by Alwyn van der Merwe, Director of Investments:
Looking only at the fiscal numbers for the current year as set out in Minister Godongwana’s MTBPS, the scoreboard is undoubtedly a positive surprise. However, this good outcome can be ascribed largely to stronger commodity prices that had a positive impact on revenue, and of course, to the improved administrative performance of the South African Revenue Service. The overall numbers will bring short-term relief in all the important fiscal ratios and, importantly, will reduce the immediate funding requirements of the fiscus.
We have argued that local government bond yields are high and offer investors an attractive investment opportunity. The bond market appears to have agreed with our view after the MTBPS and has strengthened materially. We maintain our view that this asset class remains attractively priced.
On the other hand, equity markets are currently grappling with far larger, well-documented global developments. The MTBPS won’t harm the sentiment of local equity investors. However, the short-term drivers of local equity performance are likely to be derived from dominant global macro variables and specifically the change in views regarding the trajectory of global interest rates.
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