In the context of lower-than-previously expected growth due to intensified load-shedding and falling commodity prices, on the face of it, the 2023 Budget is fiscally reassuring of it. For example, even though the trajectory of the public debt-to-GDP ratio is more elevated, this is entirely attributable to 60% of Eskom’s debt being brought onto the government’s balance sheet over the next three years.
However, the Budget makes some significant assumptions that might be unduly optimistic. From a financial markets perspective, the 2023 Budget is superficially reassuring in that the government has not succumbed to populist pressures for full spending that might be termed wasteful. This reassurance is undoubtedly supportive of the Rand not losing any further ground from current excessively cheap levels.
Key takeaways from the budget:
- Gross debt to rise from 71.1% of GDP in 2022/23 FY to 72.5% of GDP in 2025/26 FY
- Budget deficit seen narrowing from -4.2% of GDP in 2022/23 FY to -3.2% of GDP in 2025/26 FY
- Crowding in of the private sector in the electricity industry
- Eskom receives R254bn of debt relief over next 3 years
- 25% tax deduction for consumers investing in renewables
- SAA gets R1bn to help with business rescue
In the context of lower-than-previously expected growth due to intensified load-shedding and falling commodity prices, on the face of it, the 2023 Budget is fiscally reassuring. Despite pressures for increased expenditure, especially in regard to social welfare, incentives for solar energy and pressure for increased public sector wages, the National Treasury seems to have been able to budget for deficits over the next three years that are no worse than previous budgets. Even though the trajectory of the public debt-to-GDP ratio is more elevated, this is entirely attributable to 60% of Eskom’s debt being brought onto the government’s balance sheet over the next three years.
However, it is important to outline significant assumptions that might be considered unduly optimistic.
Firstly, the economic growth forecast for 2023 has been put at 0.9%. Given the intensity of the electricity crisis, problems with the country’s rail and port network, and the recent decline in coal prices, there is considerable downside risk to this forecast. The forecasts for 2024 and 2025 are slightly better, at around 1.5%, which is in line with our own most recent forecasts but is predicated on the belief that fixed capital formation might accelerate between 3.5% and 4.0% over those two years.
Given a commitment to an accelerated pace of investment in renewable energy projects and other infrastructural projects which government has outlined, the assumption is that at least some of this investment will be forthcoming. Metrics relating to government expenditure on capital assets are encouraging, with average growth in public sector fixed capital formation set at 18.9% per annum and cumulative public sector investment over the next three years projected at R903bn, which represents a meaningful increase on such projections in earlier years.
Unfortunately, based on evidence in the last couple of years to the contrary, scepticism regarding the scale of implementation of such projects cannot be cast aside. One welcomes the National Treasury’s commitment to shifting the focus of growth away from consumption towards investment, but such intentions have failed to be put into practice in the past. Secondly, in turn, if GDP growth turns out to be weaker than the government has assumed, growth in tax revenue is set to increase by 3.5%, 6.1% and 7.1% in each of 2023/24, 2024/25 and 2025/26, will not be forthcoming.
In this regard, the revenue forecast has assumed that the R93bn overrun in tax revenue in 2022/23, compared with what had been budgeted a year ago, has created a higher base from which to project revenues over the next two fiscal years at R93.7bn and R100.1bn, respectively. The assumption clearly is that the improved ability of SARS to collect tax is likely to persist and that the level of commodity prices will not decline significantly from current levels.
On the expenditure side, the elephant in the room relates to public sector remuneration. In the current budget, the growth in non-interest expenditure is projected at 2.1%, 5.0% and 4.2% for each of the next three fiscal years, which is somewhat lower than the projected inflation rate. Underlying this projection is an increase in compensation of employees in the public service of 1.6%, 3.9% and 4.4% in each fiscal year.
These remuneration levels are lower than what is currently being negotiated with the public service, namely an increase of 4.7% in the forthcoming fiscal year, followed by inflation-related increases. If one calculates the difference in Rand value of these projections, assuming that the government manages to reach a negotiated settlement with public servants, the additional expenditure will be of the order of R22bn, R27bn and R29bn over the next three fiscal years.
This would be tantamount to increasing the budget deficit by around 0.4% of GDP each fiscal year, which is not dramatic and unlikely to jeopardise the country’s credit rating. Still, it is important to put it into perspective.
On the tax front, one is gratified, albeit not surprised, at the absence of any real increase in taxation. The country’s weak economy can clearly not afford such an outcome. The scale of relief provided through incentives for solar energy is R4bn for individuals and R5bn for businesses and is to be welcomed. This is not a massive concession and is equivalent to the R4bn additional relief being provided in the form of no increase in the fuel levy and RAF levy. The compensation for bracket creep on personal incomes is also satisfactory. The other main element of the 2023 Budget is the announcement of the shift of R254bn out of the R423bn debt of Eskom onto the government’s balance sheet. The logic behind this is to free Eskom to concentrate on transmission and distribution investment without the huge debt constraint hanging over its head. Again, only time will tell whether this proves to be a successful move.
From a financial markets perspective, the 2023 Budget is superficially reassuring in that the government has not succumbed to populist pressures for spending that might be termed wasteful. The need to suppress debt levels remains uppermost in the State’s mind. This reassurance is undoubtedly supportive of the Rand not losing any further ground from current excessively cheap levels on the basis of purchasing power. It also goes hand-in-hand with relieving upward pressure on bond yields.
FX reaction to the budget and outlook
While the market is still cautious about the fragile state of SA’s macro and fiscal positions, the initial reaction from the currency market was positive, with the USD-ZAR paring back from its intraday high of 18.3851 to levels as low as 18.1249, a move of around 1.4%. The pullback in the USD-ZAR is a sign that the market was priced for more negative news surrounding the fiscal status. It just took some sign of reform and fiscal constraint and progress on resolving the rolling blackouts in SA for the market to turn less bearish on the ZAR.
While there are still some meaningful hurdles standing in the path of the ZAR, including the potential greylisting and sovereign credit rating updates from Fitch and S&P, ETM’s proprietary FX models point to a period of ZAR strength in the months ahead. The latest sell-off in the ZAR seems overdone, whether looking at currency fundamentals, currency valuations or technical indicators. The message of fiscal restraint and structural reform portrayed by the Finance Minister, together with the developments surrounding resolving SA’s dire electricity crisis, go a long way in supporting the narrative of a stronger ZAR in the months ahead.
Fixed-income reaction to the budget and outlook
The bond market reaction to the 2023 budget was generally positive, with the fear priced in ahead of it seemingly unfounded given the generally positive announcements made. National Treasury has forecast a continued narrowing of the budget deficit, even after taking into account Eskom’s debt solutions. There are, of course, downside risks to NT’s outlook. The major risk is to the growth outlook, given the government’s usual slow pace of implementing reforms. SOE bailouts may also continue to be higher than expected in the years to come, while wages always present a notable upside risk. Another notable factor is the stabilisation of debt-to-GDP expected in 2025/26. Although the debt-to-GDP ratio forecasts were revised higher owing to Eskom debt relief measures, the extra funding required over the short term will be raised by additional issuance of FRN, foreign loans, Sukuk, cash balances, and IFI green loans. As such, the issuance of local bonds can remain unchanged for now, boosting the secondary market. Overall, the 2023 budget will be supportive of the local bond market, but as ever, we caution that NT’s estimates can be on the optimistic side and require efficient implementation of reforms, which is very often not the case.