Thalia Petousis, portfolio manager at Allan Gray, shares her views on the challenges of putting together a credible national budget.
One of the most important figures that bond investors can digest at any national budget is that of the fiscal deficit, which is essentially a measure of the extent by which a government has overspent relative to its tax revenue. In short, it is an indication of how much debt a government will need to raise to fund its excess spending in every fiscal year.
Last year, National Treasury (‘NT’) estimated that the current FY22/23 main SA budget deficit would stand at -R324bn (or -4.9% of SA’s GDP). While this figure may sound like a colossal failure, income tax collection tailwinds in 2022 have actually allowed SA to move closer to a balanced primary budget, meaning that government revenues should be sufficient to cover its non-interest expenditures. In such a setting, it is theoretically easier for the government to fund itself in the event that every bondholder simply reinvests all coupons they receive, although problems can still arise where interest costs escalate enormously. A case in point is the Ghanaian government, which achieved a primary surplus but has not been able to cope with the rising cost of servicing interest on their debt, leading to an effective default.
Loadshedding woes have yet to hit the tax collection numbers
While there may be scope for small positive revisions to the FY22/23 figure in the current SA Budget, my concern lies in the credibility of NT’s estimate for the outer years of the forecast period over 2024-2026. Back in 2019, the budget forecast estimated that SA’s debt load would stabilise at 60% of GDP by 2023. At present, our debt load sits above 70% of GDP (or almost R700bn more).
Loadshedding is heavily affecting economic activities, and it would be prudent to expect a significant negative impact on corporate profitability and resulting tax collections. While several mining houses and SA corporates are showing enormous resilience and foresight in terms of streamlining their operations and generating private power, reliance on emergency electricity supply via diesel-run generators is adding to cost pressures and compressing company profit margins. The bleed-through into income tax collection has not yet been observed in the official budgetary numbers and is currently difficult to quantify.
Spending pressures to rise from ‘debt man’ walking SOEs
Perhaps more at risk than the revenue forecast is that for spending. Almost a third of all government expenditure goes towards the public sector wage bill. Importantly, NT forecasts reflect just 3% per annum growth in the government wage bill for each of the next three years – an outcome that trade unions are highly unlikely to accept. Beyond this, expenditure pressures should also arise as a result of the several state-owned entities (SOEs) that are unsustainable in their current form. As certain of these entities progress further along the road of what may be an operational death spiral, bailout demands will rise.
Eskom, for example, currently generates less than half the cash it needs to service its debt. Municipal debt arrears arising from unpaid bills owed to Eskom stands at north of R50bn, while the City of Johannesburg scrambles to borrow money to pay back its suppliers. The South African National Roads Agency (SANRAL), Transnet and Land Bank were each allocated some form of extraordinary assistance in the last budget. As such, I do not believe that the unallocated contingency reserves being baked into the budget are sufficient to meet realistic future cash demands that will be placed on the fiscus.
Although more credible future budgets may make for negative reading, South African Revenue Service (SARS) Commissioner Edward Kieswetter is adamant that, directionally, the aim is not to raise taxes nor institute new wealth taxes. Under his supervision, SARS has generated a meaningful improvement in administrative competence, tax compliance and revenue collection ability.
Another saving grace for SA’s debt markets this year is favourable foreigner sentiment as a result of global disinflation and an expectation that peak overnight interest rates may soon be reached. Much of this disinflationary positivity is the result of large base effects from a torrid year for inflation in 2022. As such, offshore sentiment is a notoriously fair-weather friend and SA must remain committed to fiscal and structural reform at all costs.