By Nazmeera Moola, co-Head of Fixed Income, Investec Asset Management
Finance Minister Pravin Gordhan delivered a pragmatic budget that is good for SA and possibly good enough for Standard & Poors for another six months. However, the bond market won’t like it.
Gordhan tabled conservative growth and revenue forecasts and significant consolidation from lower expenditure and higher taxes over the next two to three years. The slippage in the deficit forecasts vary between 0.1% and 0.3% in the current and coming years. However, the Treasury has also decided to prefund a redemption coming due in 2019 by a 20%-25% increase in domestic long-term issuance in the 2017/2018 and 2018/2019 financial years, which the bond market will not like.
Similarly, consumer stocks are not likely to respond well to the fact that tax increases of R28 billion are now planned for the next financial year, up from the R15bn announced in the February Budget. The R28 billion could potentially be made up of a number of measures, including no fiscal drag adjustment (inflation adjustment) for personal income taxes, another 1% increase in the top marginal tax rate, a wealth tax or a number of other measures. However the most efficient measure would be a 1% increase in VAT. Unfortunately the current political climate is unlikely to allow for that.
Is it enough to keep S&P on hold in December 2016? It may just be. Rating agencies care about growth. The measured consolidation that Treasury has outlined shows a firm commitment to meeting the fiscal objectives they committed to in February 2016 without killing growth. A good portion of the Budget Review focuses on the structural and regulatory measures that are required to raise South Africa’s growth rate. Unless those are implemented, growth and revenues will continue to disappoint.
There were three items we flagged to watch closely in this Medium-term Budget Policy Statement.
1) Did Treasury stick to their expenditure ceiling?
Unequivocally yes. In fact, they lowered the ceiling by R8.5 billion for this fiscal, R10.3 billion for the next and R31 billion for the fiscal year 2018/2019.
2) Will the primary balance on the main budget (excluding spending by provinces, public entities and social security funds financed from their own revenues) move into surplus in financial year 2017/18?
Yes. While there is some deterioration in the main budget deficit in the current financial year ended 31 March 2017, the forecast for 2017/18 remains unchanged at 0.1% of GDP and improving to 0.4% of GDP in 2018/19. This should allow for the debt profile to consolidate over the medium term.
3) Does the debt profile stabilize in FY17/18?
No. This was the main source of disappointment in the budget. Given Treasury’s lower GDP forecasts, the net debt/GDP ratio will only stabilize at 47.9% of GDP in financial year 2019/20, rather than 46.2% of GDP in financial year 2017/18. This is the main source of disappointment in the budget.