A Moody Budget

It’s been a week of high-highs and low-lows. On the one hand, Finance Minister Tito Mboweni delivered a sombre medium-term budget policy statement (MTBPS) on Wednesday, and on Friday, Moody’s announced a change in their outlook for South Africa from “stable” to “negative” – widely regarded as a precursor to a downgrade to sub-investment grade. Then, amidst the gloom, the Springboks delivered a world-class performance on Saturday to bring the Rugby World Cup trophy home, beating England 32-12.

MTBPS falls short

The MTBPS is not intended to announce big changes, but rather to instill confidence and reinforce National Treasury’s message. Mboweni’s attempts to achieve these aims fell short, as initial reactions from the rand and the bond market – which offer the most immediate investor feedback – both reacted negatively to the Minister’s speech. The rand immediately weakened above R15/$, while medium- and longer-term South African bonds sold off between 36 and 40 bps following the news.

Mboweni was not shy on tough talk, clearly stating that national carrier SAA is on an unsustainable path, and that Eskom is a business and must be run as such. However, he effectively passed the baton to politicians, warning government of what lies ahead should it not implement the policy reforms advocated for by National Treasury in its draft economic policy document. And the market is well aware of the divided and paralysed nature of the governing party on policy reform, which is where confidence fails.

Mboweni stated that South Africa’s debt-to-GDP ratio will reach 70% by 2022/23, and over 80% by 2028 – not accounting for state-owned entity (SOE) and municipal debt, which represent an additional 15%. Adding this debt onto the balance sheet means that when Mboweni says South Africa will reach a 60% debt-to-GDP ratio by next year’s budget, the “real number” is in fact 75% “all-in”. This is run-away debt territory and, as a result, debt-servicing is the fastest growing line item in terms of expenditure.

Closing South Africa’s primary deficit would require increasing the VAT rate from 15% to as much as 22%, or sharply raising personal income tax rates across the board. The fact that these adjustments are unachievable highlights the fiscal straitjacket in which South Africa finds itself.

Moody’s rings the alarm

On 1 November, citing the deteriorating economic environment and escalating debt, Moody’s revised the outlook on South Africa’s ‘Baa3’ rating from stable to negative – effectively leaving the country teetering one step above sub-investment grade.

Signaling a rising concern that government will not find the political capital to implement the necessary measures, and that its plans will be largely ineffective in lifting growth, this latest move serves as a last, last, last warning to a country which many argue should have run out of chances some time ago.

While a further downgrade by Moody’s could be announced at any time, South Africa now has perhaps three months in which to demonstrate a serious commitment to reform. Mboweni’s February budget will consequently be closely watched for the kind of government spending cuts and economic growth signals that may demonstrate a change in trajectory.

In particular, investors and ratings agencies will want to see real progress in stabilising the SOEs and reducing the public sector wage bill – two hot-button issues that will pit government against public sector unions which will fight to retain salaries and jobs.

SA in an economic catch-22

We find ourselves in a true catch-22. Local investors are moving much-needed funds offshore at a faster rate than foreigners are investing in the country. Only a recovery in confidence coupled with economic growth will stem the tide of this large net leakage of domestic capital, and yet we need investment capital to generate economic growth.

Risks abound. Economic growth is predicted to remain below 2% for the next few years, which still is not fast enough to absorb the number of people entering the job market. South Africa’s society is predominantly young, unemployed and unequal – a cocktail that proved catalytic to the Arab Spring.

We urgently need the kind of restructuring that prioritises the growth of small- to medium-sized enterprises, as these are the businesses that will spearheaded the kind of labour-absorptive economic growth that creates employment, redresses poverty and mitigates inequality.

Despite all this, however, the fact remains that South Africa is stronger than it was a year ago. And while President Ramaphosa faces factional divisions within his party, he has proved to be a man who plays the long game, gradually getting constituents onside, stemming the rot and laying the foundations for the hard work that needs to be done.

Although we are unlikely see a rebound into rapid growth any time soon, South Africa’s strong institutions, robust financial sector, resilient capital markets and deep pension pool are also strong attributes in our favour.

South Africa is under a microscope and the clock is ticking on a homegrown financial crisis. But with the right leadership taking tough decisions, by this time next year, we could be telling a very different story.

As we celebrate the Rugby World Cup victory, many have recalled that moment in 1995 when, making our debut on the world stage after years of isolation during apartheid, South Africa stunned the world to win the Rugby World Cup for the first time. We’re a country that constantly surprises itself with what we can achieve, overcoming seemingly insurmountable challenges and differences.

We need this same indomitable hope and odds-defying hard work now more than ever, so as we look to the difficult times that lie ahead, it is pertinent to remember Springbok captain Siya Kolisi’s words, “We can achieve anything if we work together as one.”

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