Gigaba’s mini budget raises downgrade fears


Gigaba’s mini budget raises downgrade fears

Published Date: 2017-10-26 | Source: Stephen Gunnion | Author: Stephen Gunnion

Gigaba’s mini budget raises downgrade fears

Debt is rising, the budget expenditure ceiling has been breached and higher taxes lie ahead

The risk of Standard & Poor's (S&P) downgrading South Africa's local currency credit rating to junk next month has risen following the release of Finance Minister Malusi Gigaba's first Medium Term Budget Policy Statement (MTBPS) yesterday.

Nazmeera Moola, co-Head of Fixed Income at Investec Asset Management, says the budget paints a bleak picture: the expenditure ceiling has been breached, there is no primary surplus and debt and guarantees combined are above 60% of GDP.

"Not only is the market likely to hate it but Standard & Poor's may well downgrade our domestic credit rating in November," Moola wrote in a note.

Moola says the MTBPS provides no evidence of fiscal consolidation in the medium term, which is one of the factors supporting an investment grade rating on local debt. Another is decisive action on state-owned enterprises, which hasn't materialised. A downgrade by S&P of local currency debt to junk could lead to large outflows from the country's bond market as it local debt that is included in the much-watched global bond indices, which are replicated by tracker funds. About 90% of the country's debt is denominated in rand.

Investment Solutions Executive Chief Economist Lesiba Mothata says for the first time since 1994, a presidential task team has been set up to deal with the fiscal challenges the country faces. The goal is to come up with the actions needed to restore the sustainability of fiscal policy, which will be put forward in the National Budget in February. However, Mothata says what came out of the MTBPS was only a diagnosis of the problems and the fiscal hole was quantified. The MTBPS did not indicate how these issues will be solved, deferring them to the task team.

"This represents a fundamental shift from the budgeting framework South Africa has been accustomed to since 1994, and it will have negative consequences for how markets react - including potential credit ratings downgrades," says Mothata.

Revenue collection has underperformed by R50.8 billion and the budget expenditure ceiling has been breached by R3.9 billion. To bring the debt to GDP ratio back below 60%, tax hikes will be the order of the day, with additional taxes of R40 billion needed in the next tax year.

The budget deficit is now expected to come in at 4.3% of GDP, against the 3.1% forecast in last February's budget. According to TreasuryOne, that's the highest deficit since 2009. Meanwhile, growth has been revised lower to 0.7% for this year and 1.1% is forecast for 2018.

The rand weakened to R14.10 to the US dollar, its worst level for 2017, and traded at R18.59 against the pound and R16.55 versus the euro. The R186 bond yield jumped 25 basis points to 9.10%, also its highest this year according to TreasuryOne.

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