NATIONAL NEWS - Finance Minister Tito Mboweni’s medium-term budget presentation on 30 October will most certainly be a cliff-hanger.
The landscape is precarious, but the country is not yet in free-fall, as the following key factors indicate.
South Africa has a massive debt problem
National Treasury has previously suggested that it expects a progression of gross loan debt to a high of over 60% of GDP by 2023. This implies even higher costs of servicing debt over time. An upward revision in government’s debt levels without the necessary policy initiatives to address them will not impress credit rating agencies or potential investors.
Guarantees to state-owned enterprises (SOEs) stand at more than R520 billion. Eskom accounts for more than half of this number. The bailouts of other SOEs, which are struggling to recover after years of mismanagement and corrupt practices, add even more stress to the budget. Drastic measures must be taken to restructure these entities – including selling off unproductive assets in some cases.
Some market analysts have suggested that the economy would need to grow at more than 2.5% per annum in order to balance the budget over five years. Our declining potential growth numbers suggest that this is not likely to happen. Growth in 2019 is expected to be about 0.6%.
Government revenue collections have been subdued due to weak growth and a shrinking tax base.
So far, political pressures have prevented measures being taken to curtail expenditure sufficiently.
Private sector sentiment has been soured by the slow implementation of reforms and poor economic prospects. It is now urgent that policy and structural initiatives are taken in order to promote investment spending.
A risk for all developing economies is market volatility emanating from uncertainty over the US-Sino trade dispute. One might expect borrowing costs and currency volatility to rise as tensions increase, reducing the ability for developing countries to service their debt.
This issue is even more acute due to South Africa’s reliance on external funding.
Risk of a further slide down the ratings precipice
So far, Fitch and S&P have downgraded the South African sovereign to junk while Moody’s rates the country one notch above sub-investment grade. A deeper slide into junk territory would increase the rates at which debt is funded, making it more difficult to service.
Moody’s recently stated that the country’s stable outlook provides a low probability that the country’s credit rating could change. National Treasury has previously indicated expenditure cuts of between 5% and 7% per annum over the next three years – a seemingly manageable path to longer-term fiscal consolidation. Moody’s has avoided downgrading South Africa because it expects the country’s debt to stabilise.
The current yield of South Africa’s debt implies that the market is already pricing South Africa as sub-investment grade.
A downgrade by Moody’s will initially confirm perceptions rather than change investors’ outlook of sovereign risk in a meaningful way.
However, a downgrade by Moody’s will result in total exclusion of South Africa’s debt from global indices that track investment grade debt, forcing investment managers whose mandates only allow investment grade debt to sell our debt. This could briefly cause a spike upward in yields and attract buyers of sub-investment grade debt. These would be more speculative holdings and flows thereof are likely to be more volatile over time. As such, investors are likely to require even higher real yields post downgrade.
Investors continue to find value in our South African bonds
Consider the recent successful issue of the $5 billion Eurobond. Such support may be expected to continue while yields in much of the developed world remain comparatively low.
Risk of IMF bailout remains muted
An IMF bailout might be required if:
- There are multiple sovereign downgrades deeper into sub-investment grade territory,
- Flight of capital from the country accelerates, and
- SA is unable to borrow at reasonable rates.
South Africa’s issuance of hard currency debt is a relatively small proportion of overall debt (approximately 10% at the last budget presentation). A higher proportion of hard currency debt is initially positive for the central bank’s foreign reserve balance. However, in the long run it increases the risk of being unable to manage the country’s balance of payments in a distress scenario.
The country’s floating exchange rate regime and healthy level of foreign currency reserves also help in managing the balance of payments.
Debt profile is supportive
Most of South Africa’s borrowing has been in the form of long-dated bonds, which buys some time to manage the fiscal situation gradually. Many countries requesting a bailout do so because they have debt maturing that they cannot roll over.
A potential red flag in future is National Treasury’s suggestion of increased issuance of shorter-term Treasury bills rather than long-dated debt.