Tito Mboweni has an unenviable task. In his much-anticipated presentation of the 2020/2021 Budget for the fiscal year which kicks off on April Fool’s Day, he must make the case that South Africa is finally putting its fiscal house in order. At this stage, it is hard to see how he can be persuasive.
One of his top priorities will be to try to convince rating agency Moody’s that South Africa is serious about cutting its debt and kick-starting a moribund economy that endured a decade of mismanagement and looting under former president Jacob Zuma.
For Mboweni, it must be galling, having watched South Africa’s credit rating ascend through the coveted ranks of investment-grade status while he was central bank governor. And this was after the government paid off apartheid debt, nogal. Now he has to try to protect South Africa’s last investment-grade rating, maintained by Moody’s, which most analysts expect will dispense with the fiction soon with a downgrade to “junk”, following the example set by Fitch and Standard & Poor’s.
“What Mboweni will have to say won’t be pretty,” Tara O’Connor, director of Africa Risk Consulting, told Business Maverick.
Moody’s is expected to render its judgment in March and made clear recently that it was not impressed, lowering its economic growth forecast to 0.7% for 2020 from an already paltry 1%. In 2019, the economy may have managed growth of 0.4%, and perhaps not even that thanks to load shedding.
“Slow growth of economic activity is hampering the rate of job creation. Our sub-1% projections reflect our view that the pace of economic activity will remain subdued, well below the country’s potential, over our forecast horizon,” Moody’s said.
Slower growth means less revenue flowing to the Treasury, limiting its ability to tackle swelling debt levels. The picture that Mboweni painted in October in his medium-term budget policy statement (MTBPS) — and to his credit, he is blunt and honest about such things — was pretty dire.
“The consequence of not acting now would be gravely negative for South Africa. Over time, the country would likely face mounting debt service costs and higher interest rates and may enter a debt trap,” he said.
For the current fiscal year, the budget deficit was seen reaching 5.9% of gross domestic product (GDP) — way above a previous forecast of 4.5% and the highest in a decade. A budget deficit of 3% of GDP is usually seen as an acceptable level, which is probably a bit of a thumb-suck, but it is what it is.
“The consolidated deficit averages 6.2% over the next three years, with debt projected to reach 71.3% of GDP by 2022/23,” the MTBPS said. Currently, the debt to GDP ratio is around 60%.
So Mboweni does not have a lot of room. Several economists have forecast further hikes to the VAT on consumer goods, which tend to hit the poor the hardest. And in a slow-growth economy with an unemployment rate of almost 30%, its impact will be limited as consumption is muted. Mboweni has said that cuts in the ballooning public sector wage bill — which will likely mean even less consumer spending in the short run — are also in the pipeline.
Speaking of pipelines, South Africa is not expected to become a fully-fledged hydrocarbon producer for a few years, but Mboweni may flesh out details of a fantasy floated by President Cyril Ramaphosa in his SONA address, namely the creation of a sovereign wealth fund (SWF). These things are often funded from the resource sector.
Minister of Mineral Resources and Energy Gwede Mantashe has since said that royalties from the mining industry, much of which is suddenly flush thanks to a surge in the prices of precious metals and other commodities, could be used to establish such a fund. But that money would presumably have to be diverted from other resources at a time when Mboweni needs all the money he can lay his hands on. SWFs can be a useful tool when an economy has a budget surplus and an excess of foreign exchange. That hardly describes South Africa’s fiscal position at the moment.
While much of the focus is on Moody’s and expectations of a looming downgrade to total junk, South Africa is effectively on the scrapheap already. There is a lot of talk of how South Africa’s coming exclusion from investment-grade bond indices would spark an outflow of capital, with investors dumping or demanding a bigger premium on South African debt. But many analysts and market commentators have said that such a move is already priced into the market, which means South African debt is already as good as junk.
In short, the economy is already living with the consequences of a Moody’s downgrade.
“We look at relative valuations of bonds which gives you a sense of just how much of a discount foreign investors are enjoying to part with their money to fund South Africa’s deficit. So you compare it with countries that have a similar or worse credit rating than South Africa’s and seeing where South Africa stands. And South African bond yields are relatively high by comparison. Bond holders are already positioned for the risks associated with a rating downgrade,” George Glynos, head of research and analytics at ETM Analytics, told Business Maverick.
India, for example, is also at the bottom of the investment-grade food chain, and yet its 30-year bond is currently fetching a yield of around 6.8%. South Africa’s, by contrast, has a yield of just above 10%. And India’s inflation is running at more than 7% compared with South Africa’s 4.5%. The gap in five-year bonds is narrower at around 200 basis points, but the fact of the matter is that investors are demanding a higher yield for South African debt.
India’s economic growth is also much brisker, with a rate of at least 6% seen this coming fiscal year, and that gets to the crux of the issue — an emerging economy like South Africa’s that has barely been growing for several years running is no longer really in the investment-grade league.
The rand has also lost about 8% against the dollar so far this short year, which is also an indication that “junk” has been priced into the market.
Mboweni’s job is indeed formidable. It is not just about staving off the descent into full junk status, which is already effectively a reality. It is about preventing further rating downgrades, which are entirely plausible. Getting back to investment grade will be a long, hard road, and at this stage looks to be as fantastical as an SWF. BM
"The end may justify the means as long as there is something that justifies the end." ~ Leon Trotsky
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