The 2018 Medium Term Budget Policy Statement (MTBPS) will be a key determinant for SA’s credit ratings. A Moody’s Investors Service credit ratings decision was initially scheduled for 19 October 2018. Moody’s is now expected to release its statement on South Africa’s sovereign credit rating after Finance Minister Tito Mboweni delivered the MTBPS.
Despite several pieces of bad news contained in the 2018 MTBPS, I remain hopeful that Moody’s will not revise its current rating downwards. Despite strong intentions expressed by government, the current statistics remain hard to ignore. South Africa’s economy is shrinking, with unemployment at a 14-year high of 27.7% (or 37.2% if the definition of unemployed is expanded to include those too discouraged to look for work).
The South African Reserve Bank announced earlier this year that SA is in a technical recession following two consecutive quarters of negative growth. Real GDP growth averaged just 1.6% per annum during 2012–2017, in contrast to the National Development Plan’s goal of economic growth exceeding 5% per annum towards 2030.
In the MTBPS, the National Treasury forecasts that GDP growth will slow to 0.7% in 2018, down from 1.3% in 2017, before rising to 1.7% in 2019 and 2.1% in 2020.
The MTBPS articulates a critical aspect of overestimation of GDP in government forecasts over the past six budget cycles. What this means is that weaker growth outcomes have brought about unanticipated revenue shortfalls which go some way to towards explaining the increases in government’s debt-to-GDP ratio.
Deficit widens to 4,3%, structural reforms required
Fiscal policy will remain incredibly challenged in bringing about growth in the medium term.
While economists in a Bloomberg survey estimated the budget deficit at 3.8% of GDP in the current fiscal year, the MTPBS states that main budget deficit is estimated to widen to 4.3% in 2018/19 due to ffiscal slippage since the 2018 Budget. This is by far the highest level since 2008.
Despite this bleak outlook, Moody’s Investors Service hosted a relatively upbeat investor conference in September. At that conference, the ratings agency said a change in SA’s rating was unlikely until at least after the national elections in 2019. The credit ratings agency even said that SA’s credit rating may be upgraded, depending on certain economic reforms. This is according to a credit opinion from the agency, which importantly does not constitute any rating decision.
The report compiled by Moody’s Lucie Villa, a vice president and senior credit officer who’s the lead analyst for South Africa, stated that:
“Successful implementation of structural reforms to raise potential growth as well as stabilize and eventually reduce the government’s debt burden, including through reforms to SOEs that reduce contingent liabilities, would exert upward pressure on SA’s ratings. The government is currently rated investment grade (Baa3) with a stable outlook, with a credit profile supported by a diversified economy, a sound macro-economic policy framework and relatively deep financial markets.”
The poor financial position of SoEs has resulted in government’s guarantee portfolio totalling R670 billion. Given that these entities will find it difficult to refinance maturing debt as investors increasingly require guarantees before they will provide financing, government’s contingent liability exposure is likely to remain high. The state’s exposure increased to 64.5% in the past fiscal year from 54.4% as companies drew on the guarantees.
The MTBPS contained little evidence of structural reforms, with additional bail-outs promised to various state entities, including R8 billions of additional funding to SAA and the South African Post Office.
The ever-growing public sector bill also remains a major concern. The MTBPS states:
‘The compensation of public servants accounts for a large and growing proportion of consolidated spending. Between 2006/07 and 2017/18, compensation rose from 32.8% to 35.2% of all spending, and from 53.7% to 58.1% of current spending. Compensation spending was one of the fastest-growing items in the budget, increasing at an average of 11.2% a year.‘
A three-year wage public service wage agreement was announced on 8 June 2018. The wage agreement will be implemented with effect from 1 April 2018 and covers the period 2018/19 to 2020/21. Most public service workers would receive at least 0,5% to 1% above inflation over each of these three periods. This resulted in the wage costs exceeding budgeted baselines by about R30.2 billion through 2020/21.
Last year the 2017 MTBPS was a red flag for SA’s credit rating with Moody’s expressing concern shortly thereafter that SA’s interest payments ratio exceeded the median of its peer ratings group.
According to Moody’s, more than a third of all sovereign defaults occur when countries allow fiscal imbalances to persist, resulting in unsustainably high debt burdens. When they are no longer able to service or reduce their debt, downgrades invariably follow.
The MTBPS expects gross loan debt to increase to 55.8% of GDP in 2018/19, mainly to finance the budget deficit. The weaker rand accounts for about 70% of the R47.6 billion upward revision to gross loan debt in the current year. Debt is expected to stabilise at 59.6% of GDP in 2023/24 – at a higher level and a year later than projected in the 2018 Budget.
An estimated 15.1% of main budget revenue will be used to service debt in 2021/22 compared with 13.9% in 2018/19. The cost of servicing debt is the third-fastest growing expense in the budget.
What will Moody’s do?
Rating agency Moody’s Investors Service is the last of the three major credit rating agencies to keep SA’s credit rating at investment grade level.
S&P and Fitch both downgraded SA to junk status last year, in response to the surprise cabinet reshuffle and an unfavourable mid-term budget in October 2017.
Moody’s downgraded SA’s sovereign ratings to the cusp of junk in June 2017, warning that the country could lose its investment-grade rating if its economic and fiscal strength continued to falter. A further credit rating downgrade by Moody’s would therefore take its credit rating on South African bonds also down to junk status.
A downgrade to sub-investment grade would see SA expelled from the Citi World Government Bond Index, prompting asset managers and pension funds to sell domestic bonds. This would sharply increase the cost of debt and put further pressure on the exchange rate.
The MTBPS recognises this weakness:
‘External factors will also play a major role in government’s ability to narrow the budget balance and stabilise debt. These are likely to include a general rise in bond yields, higher interest rates and further exchange rate depreciation. While most government debt is denominated in rands, reducing South Africa’s exposure to external volatility, non-residents hold 38% of South African foreign and domestic government debt. This relatively high share of foreign ownership leaves South Africa vulnerable to sudden shifts in investor sentiment.‘
The 2018 MTBPS claims that government will maintain its spending ceiling as well as national departments’ compensation ceilings. Fiscal policy and the debt management strategy will work to mitigate risks to fiscal projections.
We can only hope that the medium-term budget is sufficient to indicate to credit ratings agencies that, on his watch and in sync with President Ramaphosa’s, the buck finally may stop here.