Following the release of February’s medium-term budget statement, the South African rand reversed its losses early in today’s session to sit half a percentage point higher on a day where markets battle a heightened risk environment and the dollar continued to firm across the board.
The rand wasn’t the only financial instrument to show a source of strength, as South African banking stocks rose and yields on the benchmark 2026 bond fell to a five-year low.
While the budget itself pointed to a significant deterioration in the government’s short-term finances, with the news that the consolidated budget deficit widening from 6.3% to 6.8% through 2021 taking the headlines, the mere acceptance by the Treasury that austerity wasn’t the way out of the negative debt trajectory was enough for markets to cheer along a rally.
The deterioration of South Africa’s short-term debt profile seemingly generated the lowering of the back-end of the debt forecast as the government seeks to quickly fix its stagnating economy via tax relief.
The tax cuts, especially for corporations, along with personal income tax relief of around R2bn offset prior concerns by markets that the government would look to a sales-tax hike to plug the shortfall in tax revenue at the cost of economic growth.
This highlights a change in tact from the government after policies of tax hikes over the last 5 years failed to slow the debt trajectory, and when coupled with Eskom woes, hamstrung economic growth.
On top of the taxation adjustments, President Ramaphosa is also seeking to cap the rise in public sector pay in order to save R160.2bn over the next three fiscal years, adding to previous pledges of over R150bn worth of saving in the same time period so that revenue balances with non-interest expenditures.
The public sector wage bill already accounts for 35% of the consolidated budget and 46% of government tax revenue, but this may be a slower burning promise to deliver upon.
The government has a poor track record when negotiating with the unions and has previously fallen victim to strikes strong-arming huge real wage growth. The bloated public sector wage bill, which has increased more than 40% above inflation over the past 12-years, is part of the structural reforms highlighted in today’s budget in order to stabilise debt at a more modest level.
Concerns over the fiscal slippage, stemming from the shortfall in tax revenue, adds to the size of the future adjustment needed in order to meet the target of rebalancing revenue with non-interest expenditure in 2022/23. While this is credit negative, and may concern Moodys, it will provide support for an economy that has been hamstrung by load-shedding and inaction from the government.
The lack of urgency for fiscal reforms over the last 12 months has seen South Africa’s debt trajectory trapped in a negative spiral. While today’s budget highlights this is unlikely to change, or even stabilise in the medium-term, it marks a more proactive stance by government officials to at least address this and kick-start the economy.
In a world flush with liquidity, markets are likely to support the government’s aim of rejuvenating growth and stabilising its debt load, albeit at a higher nominal level, as long as the risk climate stabilises.
While this scenario will stoke fears that Moodys will downgrade South Africa’s sovereign credit profile, fixed income markets have arguably come to terms with this being an inevitability anyway.
As foreign investors price this risk into South African assets, the repercussions from a change in stance by Moody’s is more limited than it was in 2019. This should provide Ramaphosa and Mbowemi more room to embark on the structural reforms needed to stimulate long-run economic growth and stabilise the overall debt profile of the sovereign.
We see today’s budget as a step in the right direction and agree with the market rally, however, such optimism is likely to wane in the coming months should some of these quick fixes not bear fruit.
We believe Moodys is unlikely to change its stance before H2, instead opting to monitor the progress made by the government on structural reforms and the on goings at Eskom, but the risks to this view are elevated. Any action was better than inaction for this sense and although things are likely to get worse before they get better for South Africa, transparency and a willingness to make the hard decisions as highlighted in today’s budget are a step in the right direction.
Graph: South African rand leads EM gains as most of the currency board sits in the red on coronavirus fears
Graph: Benchmark yield on South African debt fell to a 5 year low
Should this continue, the market is likely to support the government’s endeavour until proven otherwise, but the clock is ticking before its patience runs thin. We maintain our Q1 forecast of 15.00 given our base case for a marginal improvement in risk appetite from the containment of the coronavirus by quarter-end.
In the meantime, the rand is likely to be supported below the August high of 15.5 on renewed investor optimism, ceteris paribus.
Author: Simon Harvey, FX Market Analyst at Monex Europe