ASSUME THE BRACE POSITION…

R50.8 BILLION… and counting. That’s the amount by which South Africa’s government is living beyond its means and the unpleasant result of low growth, political shenanigans and chronic mismanagement of state owned enterprises. This budget deficit is equivalent to 4.3% of the entire economy, which is substantially higher than the 3.1% deficit figure budgeted in February. To put this into perspective, EU member states are legally obliged to maintain their budget deficits below 3% of GDP.

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Financing this shortfall is becoming a problem. The government doesn’t really have a savings account that it can keep dipping into. It has liquid assets, like a 40% stake in Telkom, but that’s a little bit like selling your jewelry to pay for petrol. If the government were a person, it would ask for a raise. But the South African economy isn’t really growing (0.7% forecast for this year), and raising taxes will only put further downward pressure on growth. SARS is also starting to notice that people are less keen to pay their taxes when they read about the Guptas and state capture. This is called “weakening tax morality”. Cutting costs is a nice idea but tough to implement. For example, public sector wages are already budgeted to increase at 7.3% per year. This is higher than inflation and way above GDP growth. An ANC led government will be very reluctant to cap wage increases ahead of a general election in 2019.

All of this means that the government’s only real short term option is to borrow more money. Debt, which is currently 54% of GDP, is expected to grow by around a trillion rand to 60% of GDP by 2022. That’s a huge problem for two reasons. Firstly, the interest on all of that debt will cost South Africa over R600 million per day, that’s equal to 15c for each rand that the government makes. Putting that in perspective, interest payments from 1 January to 27 April would be able to fund free university education for all South African Students (our analysis of data from the Daily Maverick)

Secondly, people tend to notice when you plan to take on a trillion rand of extra debt. Ratings agencies S&P and Fitch quickly indicated their displeasure at the Medium Term Budget Policy Statement and there is now a serious risk that the country will lose its investment grade local currency rating in November.

South Africa’s fiscal outlook has gotten much worse since February. Debt was projected to peak at around 53% of GDP next year and then decline, but it’s now expected to carry on growing to at least 61% of GDP by 2022

South Africa’s fiscal outlook has gotten much worse since February. Debt was projected to peak at around 53% of GDP next year and then decline, but it’s now expected to carry on growing to at least 61% of GDP by 2022

But didn’t we already get downgraded…

South Africa borrows money in rands (“local currency”) and “foreign currency” (euro and dollar). SA’s foreign currency debt was downgraded to “junk” by S&P and Fitch following President Zuma’s first cabinet reshuffle of 2017. However, we still have an investment grade rating from S&P and Moody’s for our local currency debt. This is important because the vast majority of SA government bonds are local currency. The risk is that almost half of all South Africa’s debt is owned by foreigners (foreigners own a lot of the local currency debt). If our local currency debt is downgraded to junk then there will be much less incentive for foreigners to finance Mr Gigaba’s deficit and government borrowing costs (those interest payments we mention above) will keep on going up.

Another credit downgrade will also be a big knock to investor and business confidence. This will be a problem because we know that low confidence is already costing SA over 1% growth.

Where to from here…

“… political and institutional developments matter the most in determining South Africa’s longer term economic prospects and will answer difficult questions about rising contingent liabilities and corruption.” Frank Gill, S&P Sovereign Ratings Analyst

Almost everybody we speak to is taking a “wait and see” attitude about the ANC elective conference in December. We believe that if the person that the ANC chooses as its next president puts in place credible and accountable boards at state owned enterprises, replaces incompetent and underperforming government ministers, and starts to prosecute those responsible for state capture, that confidence will be restored and SA can tap into the resurgent global growth. We may actually see our first upward revisions to growth forecasts in ages. On the other hand if the next president maintains the status quo, the outcome of the elective conference is contested in court or the ANC splits, then we will be doomed to remain in Minister Gigaba’s low growth trap.

(National Treasury, EU Commission, MyBroadband, Daily Maverick, Business Day, City Press, Reuters, The Louwdown)

MARKETS

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LOCAL NEWS

Finance Minister, Malusi Gigaba, delivered a painful Medium-Term Budget Policy Statement on Wednesday. The rand jumped above R14 to the dollar and prices of stocks on the JSE that benefit from a fall in the value of the rand (rand hedges) jumped in value.  (National Treasury,  Fin24, Bloomberg, Business Day).

INTERNATIONAL NEWS

Chinese President, Xi Jinping, has announced the line-up for the Chinese Communist Party’s new Politburo Standing Committee. All 7 men on the committee are over the age of 60 and there is no obvious successor to Mr Xi, which indicates that he will seek a 3rd term as President. Some investors believe that a more powerful Xi will be able to push through bolder economic and financial reforms to protect the economy. The implications for companies wishing to do business with China according to one commentator are that they have "got to work with the party; collaborate, cooperate." (CNBC)

Kenyans are supposed to vote in a re-run of the presidential election of 8 August that resulted in the re-election of current President Uhuru Kenyatta. Kenya’s Supreme Court took the unprecedented step of annulling the election due to “irregularities and illegalities”. Opposition leader, Raila Odinga, has called for a boycott of the re-run on the basis that he believes the  Independent Electoral and Boundaries Commission has not made the changes necessary to prevent a repeat of the mistakes in the first poll. At least 50 people have been killed in violence since the first election. (FT, BBC)

Former FIFA World Player of the Year, George Weah, has taken a comfortable lead in the first round of Liberia’s presidential election. Mr Weah has given few indications of the kind of government that he would run (Africa Confidential).

 

Andrew LouwComment