JOHANNESBURG – Ian Matthews, head of business development and special projects at Bravura, an independent investment banking firm specialising in corporate finance and structured solutions, commented that the medium-term budget policy statement (MTBPS) was just enough to ensure that Moody’s Investors Service credit ratings kept the country at investment rating late last year.
So far, however, 2019 has not produced any compelling reasons to keep this rating. When Finance Minister Tito Mboweni gives his maiden Budget Speech on Wednesday, it will be important to consider the key issues that emerged in the MTBPS.
Coming out of last year’s technical recession due to two consecutive quarters of negative growth, National Treasury forecast in MTBPS 2018 that gross domestic product (GDP) growth would rise to 1.7 percent in 2019 and 2.1 percent in 2020. Matthews says that at the time, MTBPS articulated a critical aspect of overestimation of GDP in government forecasts over the past six budget cycles. “What this means is that weaker growth outcomes have brought about unanticipated revenue shortfalls which go some way to towards explaining the increases in government’s debt-to-GDP ratio.”
Deficit widens to 4,3%, structural reforms required
Fiscal policy remained incredibly challenged in bringing about growth in the medium term. The MTPBS anticipated a widening deficit of the main budget to 4.3 percent in 2018/19 due to fiscal slippage since the 2018 Budget. Should this be reinforced by Finance Minister Mboweni this week, it will by far the highest level since 2008.
Last year, a report compiled by Moody’s Lucie Villa, a vice president and senior credit officer who’s the lead analyst for South Africa, said: “Successful implementation of structural reforms to raise potential growth as well as stabilize and eventually reduce the government’s debt burden, including through reforms to SOEs that reduce contingent liabilities, would exert upward pressure on SA’s ratings. The government is currently rated investment grade (Baa3) with a stable outlook, with a credit profile supported by a diversified economy, a sound macro-economic policy framework and relatively deep financial markets.”
The poor financial position of state-owned entities (SOEs) – which has reached a peak this year through Eskom's inability to contain expenditure, find suitable remedial strategies or meet power demand – has resulted in government’s guarantee portfolio totalling R670 billion. Given that these entities will find it difficult to refinance maturing debt as investors increasingly require guarantees before they will provide financing, the government’s contingent liability exposure is likely to remain high. The state’s exposure increased to 64.5 percent in the past fiscal year from 54.4 percent as companies drew on the guarantees.
Matthews says that the MTBPS contained little evidence of structural reforms, with additional bail-outs promised to various state entities, including R8 billion of additional funding to SAA and the South African Post Office.
The 2017 MTBPS was a red flag for South Africa’s credit rating with Moody’s expressing concern shortly thereafter that South Africa’s interest payments ratio exceeded the median of its peer ratings group. According to Moody’s, more than a third of all sovereign defaults occur when countries allow fiscal imbalances to persist, resulting in unsustainably high debt burdens. When they are no longer able to service or reduce their debt, downgrades invariably follow.
The MTBPS 2018 expected gross loan debt to increase to 55.8 percent of GDP in 2018/19, mainly to finance the budget deficit. The weaker rand accounts for about 70 percent of the R47.6 billion upward revision to gross loan debt in the current year. Debt is expected to stabilise at 59.6 percent of GDP in 2023/24 – at a higher level and a year later than projected in the 2018 Budget.
An estimated 15.1 percent of main budget revenue will be used to service debt in 2021/22 compared with 13.9 percent in 2018/19. The cost of servicing debt is the third-fastest growing expense in the budget.
What will Moody’s do?
Rating agency Moody’s Investors Service is the last of the three major credit rating agencies to keep South Africa’s credit rating at investment grade level. S&P and Fitch both downgraded South Africa to junk status last year, in response to the surprise cabinet reshuffle and an unfavourable mid-term budget in October 2017.
Moody’s downgraded South Africa’s sovereign ratings to the cusp of junk in June 2017, warning that the country could lose its investment-grade rating if its economic and fiscal strength continued to falter. A further credit rating downgrade by Moody’s would, therefore, take its credit rating on South African bonds also down to junk status.
A downgrade to sub-investment grade would see South Africa expelled from the Citi World Government Bond Index, prompting asset managers and pension funds to sell domestic bonds. This would sharply increase the cost of debt and put further pressure on the exchange rate.
The MTBPS 2018 recognised this weakness: “External factors will also play a major role in the government’s ability to narrow the budget balance and stabilise debt. These are likely to include a general rise in bond yields, higher interest rates and further exchange rate depreciation. While most government debt is denominated in rands, reducing South Africa’s exposure to external volatility, non-residents hold 38 percent of South African foreign and domestic government debt. This relatively high share of foreign ownership leaves South Africa vulnerable to sudden shifts in investor sentiment.”
Matthews concludes: “This year, Moody’s appears unconvinced about the proposed plan to save Eskom through dividing it into three parts and the utility remains South Africa’s single biggest risk to fiscal and economic stability. This, in combination with a poor tax collection revenue is going to make the rating agency hard pressed to find reasons to keep the country at an investment rating.”
Content supplied by Bravura, an independent investment banking firm specialising in corporate finance and structured solutions with specialist expertise in B-BBEE ownership transactions.
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