Adjusted Budget risks further rating agencies’ downgrades

By Annabel Bishop Time of article published Jun 25, 2020

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JOHANNESBURG - The Supplementary Budget Review shows that this decade is expected to begin with a massive plunge in the health of government finances.

A fiscal deficit of -15.7percent of gross domestic product (GDP), and gross debt as percent of GDP of 81.8 projected for this fiscal year, versus the previous projections of a fiscal deficit of -6.8percent of GDP and debt at 65.6percent of GDP for 2020/21.

The rating agencies are likely to downgrade South Africa further on the back of this Budget, as the key objective of any credit rating agency is to assess the ability of a country (or corporate) to repay its debt, and with South Africa now signalling that its debt burden will rise to 87.4percent of GDP by 2023/24 has deteriorated the country’s ability to repay its debt.

It is not possible to continuously borrow out of debt, nor to indefinitely borrow to make debt payments and fund current expenditure.

Debt interest payments do have to be made to avoid default. South Africa is on a negative outlook from Moody’s, at Ba1 (BB+). The agency will likely downgrade South Africa after the Budget, if not in November then sooner. Some good news emerged from the Adjusted Budget yesterday, and that is the announcement that South Africa’s debt is projected to peak at 87.4percent by 2023/24, as opposed to pre-budget “leaks” that the debt is further estimated to rise to 90.9percent by 2023 and more than 100percent by 2025, climbing to a massive 113.85 by 2029.

However, South Africa has been falling through the credit ratings increasingly quickly, and is at BB from Fitch, while S&P Global Ratings for the country’s currency rating is BB, but its foreign currency (country) rating is BB-. The next step after BB- is single B, followed by the C grade ratings and then D, for default.

While South Africa projects a peaking, and hence stabilisation of debt is positive, it will not be enough to avoid the country being pushed into the single B credit rating categories over the course of the next few years.

This is particularly because the credit rating agencies tend to look at South Africa’s debt in conjunction with that of the guarantees it has extended to the state-owned entities debt, and the calculation, when including all these contingent liabilities, takes the figure to around 100percent of GDP.

The biggest risk South Africa faces in its massive quantum of debt issuance is investor appetite, which, while strong, will not last forever.

The huge ramp up in debt and issuance is at odds with the limited savings pool in South Africa, and will add pressure to further credit rating downgrades.

Quantitative easing globally has spurred risk appetite for high yielding bonds, but foreigners make up only about 40percent of South Africa’s bond holdings and have not massively increased their holdings this year to date, while the SA Reserve Bank (SARB)has been active in the market suppressing bond yields through its bond-buying programme.

But bond yields cannot be suppressed infinitely by the SARB, as limits exist on the quantum it can purchase. This is due both to a cap on bond purchases in primary market legislation and the Southern African Development Community’s treaty limitation that Central Banks should not provide more than 10percent of funding to the government.

The Finance Minister is set to announce tax increases in the 2021 Budget, with the Supplementary Budget not having had sufficient time to deliver these.

“The active scenario assumes tax increases of R5billion in 2021/22, R10bn in 2022/23, R10bn in 2023/24 and R15bn in 2024/25.”

The tax increases envisioned will provide a drag on economic growth, while there are still risks to the economic outlook. The 2020 Budget is not an austerity budget, but the 2021 Budget is likely to be one, if only in part.

Annabel Bishop is the chief economist at Investec.


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