Tomorrow (28/10/2020) is D-Day for the much-awaited appearance by the esteemed Finance Minister Tito Mboweni, whereby we conduct the usual litmus test of how the economy is doing and how government finances are faring. Except that this time around, there is nothing ‘usual’ about the litmus test.
2020 saw the presentation of the Budget in February and a supplemental budget in June which was necessitated by the devasting onset of COVID and the inescapable fiscal impact. This will be the finance minister’s 3rd stab at ‘taking on 2020’ and for the sake of all South Africans we hope he can pull the proverbial rabbit from a hat.
We all know that in response to the Covid pandemic, that the SA government like most around the world responded with fiscal stimulus aimed to support those in need and to ensure that the pain which inevitably would be felt was somewhat minimized. South Africa’s story is deeper than that though. South Africa’s economy is one which has been plagued by rampant inequality and misappropriated fiscal largesse over a series of years which meant that going into this pandemic and crisis, that South Africa was poorly equipped if not fundamentally disadvantaged from the get-go.
I decided to compare debt projections from the 2020 supplementary budget to similar projections from 3 years ago (the shortest time frame for any serious long-term investor). In the 2017’s MTBPS, SA’s debt load by 2020 was expected to be around 58% in 2020 (revised up from 52%). The reality has been a stark reminder that unless we start to deliver on the lofty expectations, we present ourselves, that the numbers are not on our side. SA’s debt load is currently just shy of 82% and the next 3 years will see this rise to between 87% and 106% based on the active vs. passive projections presented by the National Treasury, respectively.
Now it’s been almost 2 years since I spoke at a Standard and Poor’s conference in Johannesburg where I was asked what my most pressing concern for SA was at the time. Dusting off the proverbial crystal ball, it was not hard to land on the fiscal position as well as issues around debt sustainability. I will not burden you with growth forecasts and estimates of where SA yields and the rand are going in this post (this will need to be unpacked in greater detail in further posts), suffice to say that my bearish disposition at the time would be considered bullish right now.
The issue is a combination of the fact that the debt levels have escalated but also that the cost of financing said debt remains relatively high. SA is still one of the higher yielding emerging markets which explains why it remains well supported in global fixed income markets. SA pays a relatively high yield on its debt because of its idiosyncratic risk and global fund managers like that. They can hedge their FX exposures and still realize a tidy return in real terms as SA inflation remains contained and the SARB remains vigilant. Investor’s will know that Einstein is purported to have said that “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”.
I am a finance professional, so I tend to think in terms of balance sheets and income statements. This year alone, SA’s borrowing requirement escalated by R344bn to around R777bn. Simplistically, that is equal to around R14 000.00 for each living South African or R117 000.00 per individual taxpayer. These are generalizations. I know that its not just personal income tax which shoulder’s this burden and that corporate SA, consumers through VAT as well as taxes on trade all contribute to the pot but the number is staggering, nonetheless. It equates to just under 50% of the average salary of each and every South African, THIS YEAR ALONE. The total outstanding debt now stands just shy of R 4 trillion, R71 000.00 per South African or around R600 000 per taxpayer.
We don’t put this number on our personal balance sheets when we do our own sums but if you did all of a sudden, the ‘equity’ of each and every South African is vastly diminished.
On the income statement side, this escalating debt load means that debt service now chews up around 20% of government revenue and 5% of GDP! Until recently, National Treasury has been loath to declare these trajectories as a ‘crisis’ although it’s hard to ignore and has been cited as much in more recent communication from the Treasury. It has been a crisis for years and has just been laid bare by the pressures exerted during a global pandemic. It reminds me of the Warren Buffet saying, “Only when the tide goes out, do you discover who’s been swimming naked”. The COVID pandemic was the tide going out, but SA has been swimming naked for a while.
Enough of the doomsaying though, what am I looking out for in tomorrow’s MTBPS?
Thus far, SA’s discipline to its spending ceiling has been decent. That said, a spending ceiling is not enough, in this writer’s humble opinion, to reverse the slide. It’s the proverbial double-edged sword. If spending is cut, the economy will drown, but with SA it’s not so much the how much has been spent rather than the how. We have seen President Ramaphosa’s ambitious plans for infrastructure investment, the investment drive and putting SA back on the map. However, when the hot potato of the public sector wage bill, which comprises around 35% of expenditure comes at the risk of losing political capital, it means that stark choices must be made. The Treasury has already committed to cutting the public sector wage bill by R160bn over the medium term. However, as always, the risk lies in the execution challenges and the market will be watching closely to see progress on this front. I for one stopped holding my breath a little while ago.
Under usual circumstances, tax increases are not promulgated at the MTBPS and we will need to see if this bears out. However, given the enormity of the challenges outlined above, I believe that it is a matter of time before more revenue will need to be raised from taxpayers. The Minister may well indicate where his thinking is in this respect with changes likely to be effected as at the main budget next year. That said, and as alluded to above, SA taxes remain high. When we break this down, personal and corporate income taxes are among the highest in the world. However, consumption-based taxes at 15% remain at the lower end of the spectrum with a global average around 18-20%. This remains the golden goose per se although it is unclear as to whether VAT will be tapped again for an increase after the recent 1 percentage point increase in 2018. Wealth taxes and/or other mechanisms will be considered but I must stress, more tax is not the answer. SA needs to cut its coat according to its cloth and that means that spending needs to be redirected and prioritized. The bailing out of malfunctioning SOE’s has been a bone of contention and again, fuel for a further blog post but in short, the reality will have to bite and at some stage, some will need to be let go and other privatized. Some concrete measures here and perhaps standing up to some of his political equals here would do Minister Mboweni good.
At the time of writing, the USDZAR is trading at R16.12 and the yield on SA 10-year debt around 9.22%. A lot of this move is because of generalized dollar weakness on the FX while SA bonds remain supported for the reasons above. My fair value estimate on the rand for what it’s worth is around R15.85 right now with local risks to the upside (I will update this in subsequent posts), but with a US election around the corner, a lot of other macro may be in the driving seat other than tomorrow’s MTBPS.
These are ‘economic’ decisions but require hard political choices. In this time, when the sustainability and livelihoods of millions of South Africans depend on it, it is a question of whether we can pull a rabbit out of a hat or be led even further down the rabbit hole.
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