This article is a continuation of Five things to watch out for in the medium-term budget published on Wednesday (October 14)
6. Government’s plan to achieve fiscal sustainability
National Treasury presented two debt scenarios in June 2020. In the passive scenario, it is assumed government takes no action in response to weaker growth and higher spending relative to the February 2020 National Budget. Debt would exceed 100% of GDP by 2022 and would spiral rapidly from there. In the active scenario, government employs significant expenditure cuts to reduce the budget deficit from 2021 onwards, allowing debt to peak at 87% of GDP in 2023.
The Organisation for Economic Co-operation and Development (OECD) has sketched a third scenario, the progressive scenario, in which growth recovers to 2% by 2025 and fiscal consolidation, to the order of 1% of GDP, occurs each year until 2030 (see chart below).
Given little room to manoeuvre on the revenue front, the extent to which government digs in its heels to curb expenditure growth will determine how successful it is in achieving a stabilisation in the debt ratio in the next five to 10 years.
Treasury alluded to a zero-based budgeting approach and made mention of a debt ceiling. It is likely to reinforce these concepts at the upcoming medium-term budget and any progress in this regard would be viewed as a positive.
According to JP Morgan, SA has acquired loans from the IMF ($4.3 billion), the National Development Bank ($1 billion) and the African Development Bank ($0.3 billion), which account for about R95 billion.
JP Morgan notes that with a possible $1.5 billion in Eurobond issuance for this fiscal year, the budgeted foreign loan requirements could mostly be met without the need for the World Bank loan of $2 billion.
Debt ratio scenarios
7. Addressing policy uncertainty
Government’s responses on contentious reforms have remained vague, as these issues are a function of ideological tensions and are likely to elicit a polarised response from within the ruling party’s structures.
Land expropriation without compensation
At the start of October, Minister of Agriculture, Land Reform and Rural Development Thoko Didiza announced government’s plans to distribute 700 000 hectares (896 farms) of underutilised or vacant state-owned farming land in seven provinces. Women, people with disabilities and those with prior experience in farming will be given preference and will have to undergo a basic compulsory training programme on basic financial management, record keeping and enterprise development. The minister noted the leases would not be transferable. SBG Securities noted the amount of land is significant and equates to around 8% of the land that was distributed between 1994 and 2018. As such, this move should take some of the pressure off the debate on land expropriation without compensation.
In respect of land reform, the president previously acknowledged the need for a clear property rights regime to encourage higher economic growth.
While shorter-term efforts will likely be concentrated on developing publicly owned land, in the long term ensuring a rollout of land expropriation without compensation, in a way that increases agricultural production and food security, would be viewed as market friendly.
The main concern regarding the distribution of the 700 000 hectares of land is that beneficiaries will be given a 30-year leasehold with an option to buy. As such, beneficiaries do not have full title or direct ownership, and accessing capital could be onerous.
National Health Insurance (NHI)
The health ministry reiterated that the pandemic has merely highlighted the importance of the NHI given the shortcomings of the current healthcare system.
Government looting through the emergency procurement programme in the Covid-19 crisis highlights concerns over the management of a universal healthcare system, while stretched government finances raises concerns on the source of financing.
In March 2017, the Davis Tax Committee (DTC) calculated that at an average growth rate of 2%, the NHI scheme would hit a shortfall of R108 billion by 2025, even with financing of R265 billion a year. The DTC proposed a tax rate scenario of a 2% increase in payroll on employers, a 2% surcharge on taxable income and a 2.5% increase in Vat to fund the R108 billion shortfall. These estimates were, however, based off 2010 pricing.
Strong opposition by investors to instruct retirement funds on how to fund social development has led to the discussion on easing the barriers to infrastructure investment by providing a pipeline of bankable projects. Government aims to find ways to unlock SA’s pension funds to assist with the country’s infrastructure goals.
The Investment and Infrastructure Office quoted a study by RisCura that only 2.3% of pension assets are allocated to private equity in SA, while the global average is 24.8%. It believes there is interest, however the lack of activity in SA has meant that 83% of private equity funds are allocated outside of SA. In response, government has gazetted R340 billion (50 projects) in bankable projects. These projects are expected to create more than half a million jobs.
Government recognises that the low level of public-private partnerships (PPPs) at 2% of total investment in public infrastructure can be attributed to complex, lengthy and costly procedures and it is aiming to ensure a smoother path between inception and execution.
Regulation 28 of the Pensions Fund Act, as it stands, permits retirement funds to invest up to 35% in unlisted assets with caps on private and unlisted equity. The Association for Savings and Investment SA (Asisa) has taken the stance that Regulation 28 sets investment limits and that amendments to these limits do not equate to prescription. But it is also of the view that the current Regulation 28 provisions do not prevent increased investment in infrastructure.
Government’s economic cluster is of the opinion that Regulation 28 may be too restrictive to facilitate infrastructure investment. Nevertheless, it states that “we are moving to an environment where there is no enforced prescription, but you create an environment where trustees can invest in infrastructure profits as long as these projects are profitable”.
Sovereign wealth fund, a state bank and the nationalisation of the Sarb
Dire economic growth outcomes are realistically expected to quash any meaningful movement on nationalisation talks in the short to medium term, in our view.
8. Momentum behind structural reforms
An Economic Recovery Action Plan has been negotiated by the National Economic and Development Council (Nedlac), which houses representatives from business, labour, civil society and government. This plan is a positive stride towards social compacting and helps to redirect the radical narrative attached to transforming the economy.
The plan takes a hard line against corruption and does not look at short-term goals at the expense of longer-term imperatives. The Nedlac plan also proposes that a working committee meet at least every two months to share reports from each social partner on the implementation of its commitments to the plan.
Efforts have been focused on accelerating progress in the following areas:
- Improving efficiency at ports
- Speeding up the release of high-demand spectrum
- Stabilising finances and operations at Eskom
- Developing an exploration strategy in the mining sector
- Accelerating the announcement of bid window five of the renewable energy independent power producer programme
- Finalising a Section 34 determination to cater for procurement in excess of 11 gigawatts
- Proposing to ban public servants and politically exposed persons from doing business with the state, and
- Proposing that all government procurement transactions be transparent.
It is important to note that the Nedlac plan has not yet been endorsed by Cabinet and risks dilution. Moreover, SBG Securities warns there are weaknesses in cabinet positions that are critical to the success of the Nedlac plan.
9. Implications for SA’s sovereign rating
With no big reformist effort seemingly emerging from government, we believe the bias to SA’s sovereign rating outlook is to the downside in the medium term. Significant fiscal consolidation will be difficult without having a more detrimental effect on growth and employment, in our opinion.
With Standard and Poor’s Global Ratings (S&P) having the most bearish ranking on SA’s sovereign rating from the three main rating agencies (see table below), it is likely that the rating captures a slow growth recovery, measured fiscal consolidation and only incremental progress on reforms. At this stage, SA still boasts stronger governance than many single-B rated economies and still houses monetary flexibility and a solid, independent central bank. SA also has deeper domestic markets than the typical single-B rated economy and still has various checks and balances in place, on a relative basis. Lower external leverage further supports the country’s BB- rating.
S&P has warned that a bigger-than-expected underperformance in growth in SA (leading to greater fiscal challenges), the fiscal drain from state-owned enterprises (SOEs), a loss of property rights, and the danger of outright prescribed assets pose the largest threats to SA’s sovereign rating.
With S&P’s outlook on stable, there is a risk that the agency may lower the outlook to negative at the November 2020 ratings review. However, we are not expecting a lowering of the rating in 2020.
Moody’s rating agency views SA’s sizeable domestic savings as a policy buffer in SA and ranks the country’s low reliance on foreign-currency debt as a positive. Nonetheless, for the 19 largest emerging markets (EMs) that Moody’s covers, SA and Brazil are expected to undergo the most significant deterioration in their debt-to-GDP ratios by the end of 2021. While a wider primary deficit adds to SA’s growing debt burden, interest payments are also one of the highest as a share of revenue from the peer group. Moreover, Moody’s noted that within the 19 largest EMs covered, SA and Mexico’s contingent liabilities pose a medium-term challenge to their respective government’s finances. Although Moody’s factors in modest support to SA’s weak SOEs, it still notes the risk of widening fiscal deficits arising from larger-than-anticipated financial support.
For SA’s debt burden to stabilise by FY2022/23 at higher post-pandemic levels, Moody’s points out that SA and Chile will face the largest growth shortfalls of between 4% (SA) and 6% (Chile). Moreover, their primary fiscal gaps need to close between 3% (Chile) and 6% (SA) in order to stabilise debt (at higher post-pandemic levels). These are the largest adjustments required among the peer group of 19 EMs.
In our opinion, while Moody’s may retain its rating following the October 2020 medium-term budget, the risks to a downgrade (particularly for the foreign currency rating) remains high in 2021 as the consensus-building nature of the incumbent administration and the incremental pace of structural reform do not indicate that SA is firmly on the path to strong reform efforts to instil significantly higher levels of confidence and credibility to meaningfully kick-start growth.
Sovereign rating matrix
Sanisha Packirisamy is an economist and Herman van Papendorp head of investment research and asset allocation at Momentum Investments.