It is worth giving credit where it is due. Finance Minister Godongwana delivered the best budget we have seen in over a decade, scoring a 5 out of 10. For once, the government didn’t default to higher taxes but instead tackled the expense side of the equation by addressing the inflated public sector wage bill and shifted away from the trend of bailing out failing state-owned enterprises. In addition to this, Finance Minister Godongwana signalled that the government plans to introduce a more robust fiscal anchor in the next three years aimed at steering the country back towards a sustainable fiscal path. Although the reform pledges are encouraging, given the government’s history of failing to deliver on its reform promises, we remain cautious of turning overly optimistic until such a time as there is concrete evidence that the government is indeed delivering on these promises. However, should the government deliver, the future is looking more constructive for SA. In conclusion, we are encouraged by Finance Minister Godongwana’s budget presentation. Moreover, we expect a positive reaction from ratings agencies and could even see the likes of Moody’s revise SA’s credit rating outlook to stable from negative.

Key takeaways from the budget:
• National Treasury didn’t default to higher taxes
• Government has constrained the wage bill to well below inflation, although negotiations are set to resume
• Crowding in of the private sector in the electricity industry
• National Treasury is looking to work more closely with the private sector in general
• Government looking to reform network industries
• Fiscal metrics are better. Whether that is statistical or not is less important because the market has accepted the new numbers

Favourable external conditions and a statistical revision have resulted in drastically improved fiscal metrics

Notwithstanding the stronger than expected tax collections driven by higher commodity prices and the statistical revision to GDP, which has provided the government with some breathing room, National Treasury still finds itself in a fragile fiscal position. Years of fiscal mismanagement and wasteful spending has seen SA’s gross national debt pile increase more than threefold over the past decade. While SA’s fiscal metrics are still worrying, they are significantly better than was the case a year ago.

Encouragingly, National Treasury now forecasts that SA will achieve a primary budget surplus by 2023/24, a year earlier than anticipated in November’s MTBPS. That said, SA is still expected to run significant gross budget deficits over the medium term.

National Treasury forecast that the SA will record a budget shortfall of -5.7% in 21/22, -6.0% for 22/23, -4.8% in 23/24 and -4.2% in 24/25. With the budget deficit expected to narrow over the medium term, National Treasury expects gross debt to stabilise at 75.1% of GDP in 24/25, up from 69.5% in the current fiscal year but below previous estimates.

Debt servicing is still a significant expense item
Debt servicing costs are expected to keep rising at an alarming pace. Once again, debt servicing is the single largest expense item in the budget at R301.8bn. This is more than ten times the amount put aside to be spent on job creation and labour affairs. As has been the case for some years, South Africa’s high debt servicing costs will crowd out expenditure on other areas of the budget, including growth supportive infrastructure spending.

Borrowing requirements lowered on revenue windfall
The windfall revenue collection has helped to compress the government’s borrowing requirements going forward. The 2022 budget forecasts that borrowing for 2021/22 will decline from a projected R547.9bn in the 2021 budget to R412bn. This represents an improvement from 9.6% of GDP to 6.6% of GDP. Long-term borrowing needs will drop from the previously estimated R380bn to R285.3bn, while short-term borrowing projections have also decreased. Interestingly, foreign borrowing requirements have increased to R80bn from the R46bn projected at the last budget, with National Treasury looking to take advantage of cheaper alternatives from foreign multinationals.

For the next fiscal year, borrowing will rise to R330.4bn, representing an increase to 7.5% of GDP. It has not yet been revealed if this will result in higher weekly auction amounts from the start of the next fiscal year. It would be prudent for National Treasury to raise issuance levels to take advantage of current interest rate levels and foreign demand, front-loading their borrowing when it is most attractive. In terms of the average maturity of bonds issued, it remained at around 11.97 years, which is near the bottom of the strategic risk benchmark of between 10 and 14 years. This issuance strategy will likely remain mostly unchanged through the next fiscal year in order to manage the risk of rising borrowing costs and a potentially more volatile market environment.

Fiscal outlook remains fragile
While SA’s fiscal metrics have notably improved relative to the 2021 budget, investors should not downplay the risks facing SA’s fiscal outlook. Some of the main risks include financially distressed SOE’s, an inflated public sector wage bill, subdued economic growth, more difficult borrowing conditions and growing pressure to boost social welfare support. A deep dive into ETM’s Fiscal Resilience Model shows just how fragile SA’s fiscal dynamics are. Out of a possible 10, SA scores just 2.3, making it one of the most fiscally fragile economies in our 22-country model. Although SA ranks poorly in ETM’s Fiscal Resilience Model, it must be noted that the fiscal outlook is looking rosier than it has for a long time, and if the government delivers on its reform promises, we expect SA’s fiscal score to improve in the years ahead.

SOEs among the losers as no more bailouts provisioned
Finance Minister Godongwana spoke little of SOEs, including Eskom, in his budget speech. No further funding was provisioned for the embattled entities, with Denel being prioritised a further R3bn through section 70(2)(b) of the Public Finance Management Act to cover capital and interest payments on guaranteed debt. Eskom, meanwhile, has been approved for a special dispensation to allow the utility to access additional guaranteed debt of R42 billion in 2021/22 and R25 billion in 2022/23, which is still within the limits of its R350bn government guarantee facility.

Eskom is the biggest risk to SA’s fiscus
Disappointingly, there was very little mentioned with regard to the restructuring of Eskom. Gondongwana described the entity’s debt as “distressed” and noted that National Treasury is working on solutions to deal with the debt load in a manner that is equitable to stakeholders. The lack of clarity on this was reflected in the market reaction to the budget, as initial gains following the positive forecasts were given back as it is expected that Eskom will remain a major drag on the economy and fiscus.

SA at a cross-road of fiscal recovery or collapse

The fiscal trajectory of South Africa rests in the hands of Finance Minister Godongwana and his ability to implement the necessary reform measures needed to put the country on a path of fiscal consolidation and possibly save SA from a fiscal crisis. Finance Minister Godongwana laid bare the harsh fiscal realities and has reiterated the need for drastic fiscal reforms that target the government’s excessive expense bill, ridding of inefficiencies within the public sector, and the need for more effective tax collection. If the government delivers on its reform promises, it will boost South Africa’s economic outlook. In its latest assessment of South Africa, the IMF said that in a scenario of reforms, economic growth could be notably stronger than what National Treasury has forecast. The positive impact of the reforms can be seen in the accompanying chart.

A stronger economic environment would aid in enhancing SA’s unemployment issues and help support government revenue collection over the longer term.

Proposed reforms are encouraging but need to be delivered on
Some of the key reforms that were discussed include:

  • Electricity generation – The government freed up independent electricity generation that will encourage an estimated R128bn in private sector investment and add over 6,000 MW to the electricity mix over the next 3-5 years, that is over and above the 4,000 MW that existing mines are looking to introduce. This is in addition to the 800 MW emergency risk mitigation projects that are currently underway.
  • Infrastructure projects – 55 new infrastructure projects worth an estimated R595bn planned. Whether they deliver is the big question, but at face value sounds encouraging. There are reports that one-third of the 62 strategic projects gazetted in 2020 are currently underway. These projects do not yet reflect in the GFCF numbers, which is a little concerning, but this could be a result of many of them being still in the planning phase and not having funds fully deployed yet.
  • Transnet – Transnet is partnering with the private sector to address cable theft and vandalism on its freight railway network.
  • Removal of red tape – A red-tape cutting team established within the presidency that will seek to fast track some initiatives to help throughput in investment. This could be significant, but once again it will remain to be seen just how efficient the actual fast-tracking of projects will be.

Overall, the budget should be positive for bonds
South African government bonds have been the best performing emerging market bonds so far in 2022, and this budget, at face value, suggests that this outperformance may persist over the near term. There were a few negatives, such as a lack of detail on Eskom’s restructuring and the prospect of higher issuance through 2022/23. However, the improvement in fiscal metrics and reform narrative are positive for bonds and should outweigh these negatives once everything from today has been digested. What will be key going forward, of course, is how the proposed reforms are implemented. A lot of focus will also be on the upcoming public-sector wage negotiations, which have the potential to notably alter the country’s fiscal path, depending on the outcome.