• NT likely to increase expenditure outlook
  • Government revenue supported by commodity boom, but this will fade
  • Questions over Eskom, public sector wages, and extended social grants will need to be answered

Bottom Line

The R100bn or bigger revenue overrun and budget deficit shortfall that might be extrapolated from government finance figures in the year-to-date cannot be relied upon to continue. Against this, Finance Minister Godongwana faces substantial pressure to devote additional expenditure in certain areas.

One feels confident that he will stick to the guidelines of fiscal discipline implicit in the 2021 MTBPS and 2022 Budget he has overseen thus far. In this way, he is likely to sustain broad-based confidence in the short-term outlook for the country’s fiscal stance.

Nonetheless, this does not resolve the more fundamental problem of suboptimal growth and the inability of the government to produce an environment conducive to sustainably higher economic growth that can generate the tax revenues needed to reduce budget deficits in the public sector borrowing requirement on a more reliable basis in the medium to longer term.

Accordingly, one will be looking to the MTBPS also to provide credible outlines of government determination to address key social and structural impediments to growth.

Given that the MTBPS is likely to be more of an update of the performance of SA’s fiscus, the impact on markets is expected to be limited. That said, should we see some significant adjustments in either direction to National Treasury’s budget forecasts, we could see some price response from markets.


United Kingdom debacle provides backdrop to MTBPS

The forward guidance of international financial markets to Finance Minister Enoch Godongwana in preparing the delivery of his Medium-Term Budget Policy Statement (MTBPS) on Wednesday next week could not have been better scripted from events in the UK over the past fortnight.

The message from markets was clear. Even though one might have thought that markets might welcome the concept of lower taxes as being market-friendly supply-side incentives, the prospect of a big increase in the public sector borrowing requirement and public debt-to-GDP ratio, which is already at a record level, ultimately outweighed the potential benefits of the pro-growth policies announced by Truss. All of these proposed policies have since been overturned by her government, especially the newly appointed Chancellor of the Exchequer, Jeremy Hunt, making her tenure as Prime Minister untenable, leading to her resignation.


SA revenue collections keep debt-to-GDP forecasts on track

Godongwana will be aware that the markets will similarly keep a close watch on the parameters incorporated into the MTBPS regarding South Africa’s projected public sector borrowing requirement, budget deficit and public debt to GDP trajectory. In this regard, the South African Finance Minister has an unexpected advantage and element of breathing space. Revenue collections thus far in the current 2022/23 fiscal year continue to outpace what was budgeted for in the February 2022 Budget, much as they were able to overshoot in the 2021/22 financial year. In the first five months of the current fiscal year (i.e., April to August), government expenditure is up by 10.3% y/y, well ahead of the budgeted 2.9% growth in government expenditure.

This overshoot stems mainly from the continued benefits of huge mining profits from elevated commodity prices. This is especially the case in respect of coal mining. In the 2022 Budget, the government projected an average price of coal in 2022 of $146 per tonne. Although this was more than $20 per tonne higher than in 2021, the reality is that the price of coal has trebled this year.

The benefits for the fiscus would have been still greater had it not been for the fact that the prices of other key South African mineral exports, including platinum group metals, gold and iron ore, have fallen back this year and are falling short of what was assumed in the 2022 Budget (e.g., $1 829 per oz. for gold, $1 037 per oz. for platinum, $1 967 per oz. for palladium and $119 per tonne for iron ore.

Substantial expenditure pressure is another risk

The important conclusion is that the R100bn or bigger revenue overrun and budget deficit shortfall, which might be extrapolated from government finance figures in the year to date, cannot be relied upon to continue. Against this, Godongwana faces substantial pressure to devote additional expenditure in certain areas.

  1. The first is the public sector wage bill. Here the government had projected an average annual growth rate of 1.8% per annum in public sector compensation over the next three years. However, the reality is that it is being forced to compromise in a manner that threatens to boost the public sector wage bill by between R30bn for this year and substantially more for the following two years.
  2. The second pressure stems from the need to prolong a social welfare safety net for more than 10m unemployed persons who have become accustomed to receiving a special social grant of R350 per month, but which grant expires at the end of the current fiscal year. Extension of this grant as a partial sop to those calling for a much more ambitious Basic Income Grant would amount to an additional outlay by government of R45bn per annum in each of the next three years.
  3. Thirdly, the government is intent on taking on a lot of Eskom debt onto its own balance sheet to help the utility stand on its feet more easily financially.

Debt servicing costs have surged

Finally, long-term interest rates have risen globally, putting upward pressure on domestic long-term interest rates, thereby increasing the potential debt-servicing costs by between R10bn and R20bn per annum. If the government could rely on the R100bn-plus current overrun on revenue to continue, it would be possible to accommodate much of the above-mentioned additional pressures on the public purse. The chart to the right illustrates the actual figures up until the end of the fiscal year 2021. Beyond that are the projections released by National Treasury at the February budget update. The increase in interest rates globally since then has far outstripped what was projected, suggesting that the figures going forward may be even greater than those illustrated in this graph. At over R300bn expected,  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, SA’s high debt servicing costs will crowd out expenditure on other areas of the budget, including growth-supportive infrastructure spending.

Market Outlook

Leading up to the announcement, South Africa’s yield curve has shifted higher quite notably since the February budget, with the front end driven higher by tightening monetary policy, while longer-dated yields have seen greater fiscal risk priced in. This increase in fiscal risk premiums has been most significant in recent months, as investors price in for slowing revenue growth and account for Eskom’s continuing failures, and rising public sector wages. If the government is to arrest this steepening of the curve and increase in fiscal risk, prudent policies are needed. Now may not be the time that these are announced, as such developments are typically left for the February annual budget. The MTBS is more of an update mechanism and thus investors will be looking to see how well SA has adhered to its targets set out at the last budget. Therefore, there are two-way risks to the bond market, but we see them skewed more towards the upside for local bonds, given the positive revenue performance mentioned above.