South Africa’s Debt Challenge, Fiscal Tightening to Keep Recovery Weak
South Africa's Finance Minister Tito Mboweni

South Africa’s Debt Challenge, Fiscal Tightening to Keep Recovery Weak

Exiting debt challenges, rising unemployment rate will impacts the South Africa’s economic performance in 2021 as government continues to implementing fiscal tightening to keep debt ratio down.

It has not been easy for citizens to keep their jobs due to high unemployment rate recorded in the last quarter of the year 2020.

Projected to grow 3.3% in 2021, heavy debt profile appears to have bedridden the country’s economic performance in recent time, though revenue recovery has started to build up.

South Africa’s budget for the fiscal year ending March 2022 (FY21/22) reflects an improvement in the fiscal trajectory relative to earlier forecasts by Fitch Ratings, the agency said in a report.

Also, Capital Economic thinks the country fiscal position is shaping up to be less dire than feared, fuelling an optimistic tone from Finance Minister Tito Mboweni.

Based on data, the country’s unemployment rate printed at 32.5% in the final quarter of 2020 amidst global pressure from the outbreak of COVID-19.

Public finances has been threatened due to the pandemic, exacerbating the existing pressures.

Essentially, there have been no change to fiscal consolidation plans as the Treasury expects the debt-to-GDP ratio to peak at 88.9% of GDP in FY 2025/26 – well below the 95.3% previously estimated.

In a report, Fitch said despite the improvement, severe challenges to the government’s ability to implement consolidation persist.

It noted that government debt will continue to rise in the medium term, posing downside risks that are reflected in the negative outlook on the sovereign’s ‘BB-’ rating.

Fitch explained that government’s consolidated fiscal deficit projection in FY20/21, at 14% of GDP, is slightly smaller than the 15.7% it had projected in the October Medium-Term Budget Policy Statement.

It added that the better performance in FY20/21 partly reflects higher-than-expected revenues, which the government projects will exceed its October forecasts by around ZAR100 billion (2% of GDP).

“Fiscal inflows have been boosted partly by the rebound in mining commodity prices and a stronger-than-expected recovery in domestic demand”.

As noted, spending in FY20/21 will be around ZAR38 billion (0.8% of GDP) lower than what Fitch had expected when we downgraded the rating from ‘BB’ in November 2020.

“This follows a court decision in December ruling that the government did not have to adhere to a previous three-year wage agreement with public-sector labour unions.

“An appeal by unions to the Constitutional Court over this verdict is still pending”,

Given the stronger starting point, the Ratings stated the government has improved its projections for the fiscal deficit through FY23/24 by around 1% of GDP per year and now targets to stabilise gross government debt at 89% of GDP by FY25/26 versus an earlier target of 95% of GDP.

Under the medium-term expenditure framework, the South Africa authorities aim for 8.6% of GDP improvement in the consolidated primary deficit between FY20/21 and FY23/24, the bulk of which will come from the phasing out of pandemic-related spending and a lower wage bill.

“They expect to achieve a primary surplus in FY24/25”, the Ratings said.

Fitch said the government plans to cut non-interest expenditure by around 2% of GDP relative to pre-pandemic levels, half of which will come from lower payroll spending.

“We continue to believe that cuts of this scale will be difficult to achieve and maintain more conservative assumptions than the government about the pace of fiscal consolidation.

“Around 1% (in GDP terms) of the improvement in the primary balance will be achieved through a gradual recovery in revenue receipts post-pandemic, but the government has withdrawn plans for a minor three-year tax package, worth ZAR40bn over the full period, that it had announced in the June supplementary budget”.

Curbing wage growth remains core to the government’s medium-term fiscal consolidation plan, but will be politically challenging.

The report stated the smaller-than-expected fiscal deficit in FY20/21 may give unions leverage to pressure the government to soften its position on wages.

But Fitch thinks the political calendar will also weaken the government’s negotiating position.

It also explained that local elections are due later in 2021 and tensions with its union allies could undermine the ruling ANC party’s performance at the polls.

Ongoing conflicts within the ANC, notably over governance issues, are now at a crucial juncture and could also hamper the government’s negotiating position.

Fitch said in the report that the government will face other challenges in meeting its fiscal consolidation goals.

The Ratings noted that structural bottlenecks has continued to hold back medium-term growth prospects, although it forecasted GDP growth to rebound to 3.6% in 2021, mostly reflecting base effects and the sharp recovery in mining prices.

“Weak growth will complicate the authorities’ efforts to reduce the budget deficit while simultaneously attempting to tackle exceptionally high social inequality and elevated unemployment”.

Meanwhile, the potential need to extend further financial assistance to troubled state-owned enterprises, including the ailing national electricity company Eskom presents material downside risks to public finances, the Ratings said.

“The South African 2021 budget unveiled was anything but the “non-austerity” budget that Finance Minister Tito Mboweni claimed he was presenting”, Capital Economics, a London-based economic research consultancy said in a report.

Indeed, the firm believes the fiscal plans imply significant tightening and will, if implemented, stabilise the public debt ratio by the middle of this decade.

“But that will keep the recovery weak and raise the risk of fiscal slippage”, it added.

Capital Economic said South Africa’s fiscal position in the 2020/21 fiscal year is shaping up to be less dire than feared, fuelling an optimistic tone from Finance Minister Tito Mboweni.

“Government revenues held up better during the pandemic; compared to the Medium-Term Budget Policy Statement (MTBPS) estimate, revenues for the 2020/21 fiscal year are projected to be 1.4% of GDP higher.

“With the spending outturn largely unchanged, the overall budget deficit has been revised to 14.0% of GDP (compared to 15.7% of GDP in the MTBPS)”, it noted.

But the government doesn’t seem to be using this breathing space to water down its austerity plan.

On the revenue side, the government’s intake is projected to increase as a share of GDP in the next two years (to 28.9% in FY 2022/23), Capital Economics noted.

It estimated that Alcohol and tobacco taxes will be raised, and the fuel levy will increase as well, also noted that on the expenditure side, restraint appears to be the order of the day.

“Allocations to fund the country’s vaccination campaign, up to ZAR19bn, were below earlier Treasury estimates.

“Total primary expenditure is projected to decline from 31.9% of GDP in FY 2020/21 to 26.2% of GDP in 2023/24, in line with the MTBPS”.

Over the same period, the report noted that the headline budget deficit is expected to fall from 14.0% of GDP to 6.3%.

With a smaller pandemic-induced hit to public finances and essentially no change to fiscal consolidation plans, the Treasury expects the debt-to-GDP ratio to peak at 88.9% of GDP in FY 2025/26 – well below the 95.3% previously estimated.

The improvement in the debt trajectory prompted, initially at least, a positive response from investors.

“We think that the outlook for public finances is not as rosy as Finance Minister Mboweni’s hopeful speech suggests”, experts stated.

The economic research consultancy company said the implementation of the fiscal consolidation plans still faces significant risks.

It’s notable that the language around a planned contentious public sector pay freeze (which formed the bulk of the expenditure restraint outlined in last October’s MTBPS) has been changed to “fair negotiations” over wages.

Adding that it will remain politically challenging to maintain expenditure restraint given the weak economic backdrop.

Indeed, data published recently showed that the unemployment rate hit 32.5% in the final quarter of last year.

The Treasury only expects GDP growth of 3.3% in 2021 and 2.2% in 2022.

“Even our own more optimistic forecasts (4.3% and 4.0% respectively) mean that GDP will remain 1.8% below its pre-crisis path by 2022”, Capital Economics stated.

“Against that backdrop, there remains a significant risk that the government won’t be able to live up to investors’ hopes, which could put the rand under pressure and cause bond yields to rise”, it noted.

South Africa’s Debt Challenge, Fiscal Tightening to Keep Recovery Weak