South Africa: Government unveils market-friendly budget; hopes to avert credit rating downgrade on 23 March
March 19, 2018
President Cyril Ramaphosa’s government faced its first major test on 21 February, just six days after Ramaphosa took office, with the unveiling of the 2018 budget. The bill was closely scrutinized by markets, and a credit rating decision by Moody’s, due on 23 March, depends on the government’s fiscal plans. A downgrade would mean that all three major credit rating agencies, including S&P Global Ratings and Fitch Ratings, would rate South African bonds as sub-investment grade or junk. It would likely trigger a sell-off of South African debt; put pressure on the currency, exacerbating the country's debt burden; and could derail the incipient economic recovery. While most analysts consider that the measures introduced will be sufficient to stave off a credit rating downgrade, at least in the near term, more needs to be done to address structural imbalances.
Since Ramaphosa became head of the ANC last December and subsequently assumed the presidency, confidence has generally improved, which could play into the upcoming decision by Moody’s. Commenting on this, economist Peter Attard Montalto, of Nomura, argued that a credit downgrade would be averted not by the specific policies in the budget, but by restored political confidence owing to higher expectations of better economic management and policymaking:
“The budget was minimally sufficient to stabilize debt-to-GDP below 60%, but overall growth is doing most of the heavy lifting. However, the political transition should mean agencies give some benefit of the doubt in the short run and so we expect Moody's to leave its ratings unchanged this month, but long-run ratings risk remains from Eskom and other fiscal shocks like public-sector wages.”
The budget includes a mix of higher taxes and more moderate spending. An increase in the VAT, the first since 1993 (from 14% to 15%, effective 1 April), was the most notable provision, reaffirming Ramaphosa’s commitment to mending the economy despite the political costs. Higher taxes on alcohol and tobacco, fuel and luxury goods were also introduced, while adjustments were made to the tax brackets on top income earners. These measures are aimed at lowering the fiscal deficit, from an estimated 4.3% in FY 2017/2018 to a revised 3.6% in FY 2018/2019 (previous estimate: 3.9% deficit) and further the next fiscal year. The government now forecasts the public-debt-to-GDP ratio will start declining in FY 2023/2024, after stabilizing in fiscal years 2021/2022 and 2022/2023 at 56.2%. Previously, it had been seen steadily increasing until FY 2025/2026.
Overall, the budget’s provisions were modest overall. The debt-to-GDP outlook is set to remain elevated and decline only modestly in the long-term, while the fiscal deficit will also remain sizable. The budget is based on an assumption of 1.5% growth in 2018 and a 1.8% expansion in 2019, but public accounts could deteriorate further if growth sputters or tax collections underperform. Major challenges such as governance of state-owned enterprises (SOEs), the sustainability of government spending and the debt burden of SOEs, a weak legal framework, and job creation still need to be addressed; these are necessary to improving the economy’s momentum and healing public finances. On this point, senior economist Elize Kruger from Oxford Economics stated, “If structural problems are not addressed in the coming years, growth will remain sluggish over the longer term.”