The response to the Budget was evidently market-friendly, with the rand, sovereign bonds and those equities indexed to general confidence and overall aggregate demand (such as banking shares) all rallying meaningfully in the immediate aftermath of the speech.
The government’s stated intention to lower its debt issuance profile over the medium-term expenditure framework was a material announcement. It stood in contradistinction to the most recent fiscal debt issuance programs. Debt issuance, and by extension, debt servicing costs had been one of the fastest-growing expenditure areas, and the suggested plans for a reduction in bond issuance over the medium-term expenditure framework was met positively by the bond and currency markets. One of the key (lingering) investor concerns about the domestic bond market had been the prospect of increased supply coming onstream, which (data suggests) is generally met with weaker clearing yields at bond auctions.
Though a smart, sober and responsible Budget, South Africa still has some way to go before it is likely to regain its investment-grade status. Credit ratings are very slow-moving assessments – particular to the upside – and SA will need to demonstrate its progress on a range of metrics required before a ratings “upgrade” could be considered.
However, South Africa and Brazil are already rated below investment grade. Yet, both have enjoyed periods of robust non-resident inflows into its capital markets after transitioning to sub-investment grade – and that is likely to continue for the foreseeable future.
Global developed bonds provide meagre starting yields and significant downside asymmetries. In a context of pervasive liquidity, accommodative policy stances, and a risk-centric mood, most high-yielding EM destinations (with few exceptions) will enjoy reasonable capital support, irrespective of their “official” credit ratings. We believe foreigners will remain a meaningful presence in the South African bond market through the cycle. This means that there may well be periods of capital flight, followed by reinvestment. But in a global environment of still very low developed market yields, high yielding emerging market currencies and bonds cannot be ignored for long periods.
Most proximately, bonds and yield assets stand to gain if the government can lower its long-term cost of capital. Other assets, such as those more cyclically sensitive to overall aggregate demand, may well also benefit from a meaningful turnaround in business confidence and capital formation on the back of the political will for reform shown in the Budget.
Looking further out, there are aspects of the budget – such as the reduction in debt issuance and the curtailing of the public wage bill – that will undoubtedly continue to be positive for a range of financial assets in the longer term.
From a PIM perspective, the outcomes of the Budget have not changed our views. But what could change is the “time to payoff”, with some of our positions possibly paying off earlier than expected.
Below we share what we consider the top five 2020/2021 Budget highlights:
1. The government’s consolidated Budget deficit declines to 14% of GDP versus the previously expected 15.7% of GDP
The outperformance of the consolidated deficit relative to 2020 MTBPS expectations is a pleasing development, but what was more laudable was the demonstration of political will to stabilise the fiscus over the medium-term expenditure framework (MTEF). Specifically, (a) the use of excess cash to reduce debt issuance over the MTEF (ultimately lowering debt servicing costs), and then (b) maintaining a firm stance on public sector compensation.
2. No increase in taxes
There was somewhat of a positive surprise on taxes: due to a recovery in consumption and wages in recent months, and mining sector tax receipts, 2020/21 revenue collections are expected to be R99.6 billion higher than estimated in the 2020 MTBPS.
As a result, the government will not introduce measures to increase tax revenue in this Budget, and previously announced increases amounting to R40 billion will be withdrawn over the next four years. The main tax proposals that were announced included an above-inflation increase in personal income tax brackets and rebates, which is a tax relief for employed individuals, and an 8 per cent increase in alcohol and tobacco excise duties.
3. SARS collected R99.6 billion more for the fiscal year than projected in October last year.
The best news of the Budget was the tabling of the decision to reduce debt issuance over the medium-term expenditure window, using cash balances that had been buffered by revenues performing better than MTBPS expectations, as well as the current funding program outperforming its targets. Reducing the borrowing requirement will, by extension, reduce debt servicing costs and ultimately assist in lowering the sovereign’s cost of capital.
4. The 2021 Budget proposes measures to narrow the main budget primary deficit from 7.5 per cent of GDP in the current year to 0.8 per cent in 2023/24.
It is an ambitious target, and it is difficult to be definitive and deterministic about outcomes for the outer year deficits because there are so many interacting variables at play.
Any scenario that models the narrowing of our deficits (both main and consolidated) inevitably rests on the following core pillars:
- Credible evidence of the political will to make hard choices related to curtailing public sector expenditure and stabilising the debt trajectory
- Related to this, and dependent on this, a lowering of the long-term sovereign cost of capital
- Policy certainty on issues such as land reform and asset expropriation
- Related to this, and dependent on this, a revival in business confidence and capital formation, which would together ultimately guide SA back onto a path of sustainable, demand-led growth.
The main hurdle that could stand in the way of achieving the government’s deficit target by putting these core pillars in place is the very real prospect of slippage with regards to expenditure priorities. Curtailing public sector wages is bound to be met with resistance, and the ruling party’s voter base could well become antagonised and fractious if they feel “sold out” by ruling party elites.
5. 1 percentage point cut in corporate tax from April 2022.
Many aspects of a budget may have importance more due to a “signalling effect” rather than an “absolute financial effect”. The cut in corporate tax is small in absolute terms. Still, it is an encouraging signal to the business community that the government is aware that, beyond a certain point, incrementally taxing the private sector produces negative marginal revenue effects.
Are these decisions sufficient to get the government back onto the road to fiscal recovery? There are two dimensions to this, one of which are the expenditure containment measures. These were well-articulated and indicative of the necessary political will to effect reform.
But overall fiscal consolidation will very much rest on real economic growth improving markedly in the medium term, which, in turn, rests on business confidence and levels of fixed-asset investment improving markedly. Whether this will happen in practice remains to be seen, and thus, while we may have taken a few critical steps in the right direction, there’s no doubt a long road still lies ahead for the National Treasury. DM/BM
This article was written by By Reza Ismail, Head of Bonds at Prescient Investment Management
Prescient Investment Management (Pty) Ltd is an authorised financial services provider (FSP 612).
The value of investments may go up as well as down and past performance is not necessarily a guide to future performance.