Macro economic commentary – October 2017

Author: Ntsekhe Moiloa.

The troubles at the South African Revenue Services are having real world consequences for the national wallet. National Treasury has tax buoyancy expected at1.1 times in the current year and above that in coming years. Tax buoyancy has actually been coming out at about0.9 suggesting that macroeconomic policy is being programmed off an overly optimistic expectation of government’s ability to collect taxes. In essence, tax buoyancy at1.1 suggests that growth in tax revenues should be about 1.1 times growth in economic output. When the actual result is 0.9 in a particularly weak economic patch, then the budget shortfall is amplified.

While revenue expectations are more realistic than they were in previous budgets, the finance minister failed to take advantage of this more sober approach by moving expenditure growth notably lower. Forecast annual expenditure growth is little changed at levels well above6 percent over the three year period, even as revenue growth in this fiscal year has been penciled in at 5 percent. The revenue shortfall for the current fiscal year is expected to be ZAR50.8 billion, widening to ZAR 69.3 billion and ZAR 89.4 billion in the subsequent two years.

South Africa ought to take heed of elements of Brazil’s approach to its fiscal quandary a little more than a year ago. Also faced with no fiscal headroom, the new government of Michel Temer set limits on expenditure growth. Critically, the limits must not be limited to central government spending but also to the money that leaks from government through the constant calls for cash from its State-Owned Enterprises (SOEs), and from its political inability to actually cut expenditure that is frankly unnecessary.

The rands-and-cents reality is that the South African state needs to go on a diet. At present, it appears unwilling to do so. Unsurprisingly then, the gross debt ratio will not stabilise at current levels as previously promised, and is instead expected to rise beyond 60 percent in the 2021/22 fiscal year. Perhaps most worrying, under “Macroeconomic risks” in Annexure A of the full Medium Term Budget Policy Statement (MTBPS) is a scenario B which shows the possibility of the debt ratio rising to nearly 90 percent if the country’s local currency debt were to fall below investment grade while global growth weakened and local inflation rose to6.6 percent.

In the past fiscal year, debt service costs as a percentage of the main budget were12.9 percent, up from 8.8 percent in 2008/09. They are projected to rise to 14.9 percent of revenue by 2021/22. By contrast, debt service ratios for the South African private sector have improved marginally, according to the latest annual report by Bank for International Settlements. While the government has not identified additional revenue raising initiatives in the MTBPS, there can be no ruling out the possibility that measures could be proposed in the February budget. Public finances are in such a parlous condition that the government is more inclined than usual to find ways of raising funds from a tax paying public that is otherwise actively trying to manage its own costs down (including increasingly choosing cheaper cars).

An attempt at marketing so-called energy bonds in Ghana at the end of October showed the risks that a state faces when it lacks financial capacity to back important initiatives. In the context of unreliable electricity supply and looming repayment deadlines on bank loans, Ghana set up a special purpose vehicle that would receive energy levies to support coupons in a local currency debt issue. The special purpose vehicle would not however have any other recourse to the sovereign. This structure was chosen so that the debt would technically not add to Ghana’s already large debt pile of more than 70 percent of GDP, breaching agreements made with the International Monetary Fund for a 3-year credit facility. Although the debt would be supported by energy levies and offered nearly20 percent yields, the absence of a sovereign guarantee resulted in little interest. Yet successfully concluding the debt sale is important to recapitalising the energy sector, as well as replacing bank credit that can be redeployed elsewhere in the economy.

In the context of an emerging reluctance by commercial banks to roll over bank loans to South African SOEs, the case of Ghana should serve as a beacon to South Africa macroeconomic policymakers. However, the challenge for the South African policymakers is much deeper than how to encourage portfolio flows; the country must also fight to retain the interest of foreign direct investors.

It is easy enough to observe that we have experienced an extended period of global low interest rates. In that period, money has been cheap, plentiful and seeking both yield and opportunity. In October, we saw offshore investors ending up as net sellers of South African bonds to the tune of ZAR10.6 billion; a large part of this selling happening in the aftermath of the MTBPS. In the final two months of the year we look forward to some decisions by ratings agencies and an important elective conference for the governing party. While we do not expect offshore investors to constitute a reduced fraction of the debt holders in South African sovereign bonds, we wonder about whether the yield levels the various kinds of offshore investors will hold our debt at will have experienced a long term structural shift upwards.

Figures for foreign direct investment (FDI) show that South Africa continues to attract the lion’s share of FDI directed at the African continent. This has happened despite a weak economic patch in South Africa and as most other economies around the world obtained better GDP growth results. For the past year however, global trade uncertainty has been elevated as the United States has threatened to reverse course on more integrated global trade. In a climate of increased barriers to trade, FDI interest tends to wane. The global professional services firm, EY (formerly Ernst & Young), reported a drop of12.3 percent in the number of FDI projects coming to
Africa in their latest review period.

Despite its current pre-eminent position in FDI, we see South Africa’s long term decline in productivity as an on-going Achilles heel which could eventually scupper its opportunities at the FDI table. No rational person should wish to commit money to a patently unproductive person with the hope that the said unproductive person will generate a reasonable economic return. Similarly, as a country’s productivity moves in the direction of zero, that country increases its risk of not being allocated FDI projects.

Considering the fiscal challenges and the longer term productivity challenges in South Africa, investors face obvious risks until the country’s leadership can articulate a more clear-sighted approach in its economic management.