A year ago, Covid-19 was something happening in China. The main focus of the then upcoming South African Budget 2020 was our ability to retain our last remaining investment grade credit rating from Moody’s.

Fast-forward to April 2020 and forecasters were rushing to downgrade South Africa’s growth outlook. At the time, we saw forecasts of contractions in 2020 of up to 14%. By June 2020, it was generally accepted that South Africa would face a revenue shortfall in the current fiscal year that ends on 31 March 2021 of around R300-billion. This was reaffirmed in the late October Medium-Term Budget Policy Statement (MTBPS). 

However, in the last three months, expectations have shifted. The bounce-back in the South African economy in the final quarter of 2020 was much stronger than expected. A widespread (false) belief that the virus was under control coupled with strong commodity exports supported both the economy and government revenues. Coming into 2021, the general assessment was that South Africa’s economy contracted by about 7%-8% in 2020. Rising commodity prices globally boosted the terms of trade and supported the South African economy last year. 

By mid-January, we had begun to suspect that revenues would surprise, notably to the upside relative to the MTBPS estimate – this would be the first positive revenue surprise in many years. The release of the December revenue collection data has seen forecasters rush to estimate full fiscal year revenue over-runs of R35-billion to R150-billion. With three months of data still outstanding, the range is large.

The revenue over-run is supported by a combination of better than expected personal income tax, strong VAT collections and a significant upside surprise to corporate income tax collections. The latter has been boosted by very strong profit growth in the mining sector. In 2019, the mining sector paid around R22-billion in tax. Estimates have the 2020 payments up to between R35-billion and R40-billion. 

This is good news. The smaller contraction in both the economy and revenues bodes well for the coming fiscal year, starting on 1 April. It suggests there has been less erosion of the productive and tax-paying capacity of the South African economy than feared. But, let us make no mistake: a 7%-8% GDP decline still marks the largest contraction since the Great Depression. South Africa’s revenue may be ahead of October 2020’s expectation – but those expectations were for a very dire R300-billion shortfall from the February forecast. 

In February 2020, the key risks to the fiscus were the government wage bill and capital requirements of badly run, inefficient state-owned enterprises. Twelve months later, these risks remain. 

In the last year, the government has held the line on the public sector wage increases. In order to ensure long-term debt sustainability, it must continue to do so. The government wage bill has gobbled up an increasing share of the state budget in recent years. While we all believe that health workers deserve a bonus in gratitude for their tireless work of the last year, the same may not be true of other civil servants and many (though not all) teachers – who have made every excuse not to return to work. South Africa spends a far larger proportion of GDP on public school teachers’ salaries than most countries in the world – and gets far worse results in return. 

With regard to state-owned enterprises, it is inevitable that there will be increased allocations to some of the problem children, but these need to be limited. The beleaguered SAA, where the business rescue practitioners appear to have greatly exacerbated a bad situation, cannot receive further funds. We need a long-term final solution for Eskom’s balance sheet – rather than the drip feed of R23-billion per annum. 

In October, South Africa’s debt, including guarantees, was forecast to reach 100.5% of GDP within the next four years. While it may now peak a little below this, interest costs will still account for an increasing share of expenditure in the coming years – rising from 12% currently towards 20%. This is after the revenue over-run is taken into account. R1 in every R5 the government spends will soon be used to make interest payments. 

We estimate that the higher borrowing costs due to the deterioration in the fiscal balances since 2016 added R52-billion to borrowing costs in the current fiscal year alone. South Africa is currently issuing R8.6-billion of bonds every week. As a result of the rising debt burden, interest costs will consume 21.2% of revenues in the current fiscal year. In much of the world, this ratio is below 5% due to much lower borrowing costs. 

So long as investors worry about the long-term trajectory of South African government debt, borrowing costs will remain high – and could well rise further. 

The solution to South Africa’s debt sustainability is to reduce borrowing costs by containing expenditure and boosting growth through structural reforms. 

It is therefore imperative that the government hold the line on expenditure in the 2021 Budget and through the upcoming wage negotiations. It must guard against the temptation to view the revenue over-run as a windfall that can be spent to satisfy questionable demands. Failure to do so will result in any benefits of higher revenues being completely eroded by higher borrowing costs. 

In the last year, National Treasury did an excellent job of ensuring the government had the cash available to meet its commitments through a very difficult and volatile period. In the face of collapsing revenues, it raised the size of the weekly bond auction on two occasions, from R5.5-billion/per week in February 2020 to R7.5-billion/week in May 2020 and R8.6-billion/week in July 2020. For reference, weekly auctions were R3.5-billion per week in February 2019. It is a testament to the strength of the South African bond market that this surge in issuance could be absorbed. However, the large amount of debt that is being issued weekly makes the market (and thus interest costs) vulnerable to changes in risk appetite. 

The MTBPS outlined a plausible path to budget consolidation. With revenues running ahead of expectations, the National Treasury has an opportunity to reduce issuance – by about R2-billion per week. While bond yields have rallied by around 50 basis points in recent weeks, if the market were able to gain confidence in the commitment to control expenditure growth going forward, we estimate that bond yields could rally by a further 50 to 100 basis points. Due to the large quantum of debt being issued, this would quickly result in large annual savings in interest costs. 

A reduction in issuance by National Treasury following the February Budget would signal to the bond market the government’s commitment to consolidate the fiscus. Given the current large government cash balances, a continuation of the high levels of issuance would raise serious doubts about the government’s commitment to further consolidation. In such a situation, the bond market would focus on the message being sent by the debt management office rather than the contents of the Budget. 

We are hopeful that the message the debt management office sends is aligned to the Budget. This would help to lower borrowing costs across the economy as a whole – including for capital investment and infrastructure projects. Lower interest costs will support growth. DM/BM