The one thing Finance Minister Malusi “Gigabyte” Gigaba cannot be accused of is giving off a false pretence that all is going smoothly on the fiscal front. Presenting his maiden budget speech (in an uncharacteristically boring suit), Gigaba departed from tradition and laid out the full extent of the state of South Africa’s fiscal position. And while this may not be welcome news to us all, it is far better to acknowledge one’s problems than pretend that they do not exist. Only seven months into the job, the old cliché of “do not shoot the messenger” may be apt.
Focusing on the numbers, a couple of statistics presented in the Medium-Term Budget Speech immediately stand out. The fiscal revenue shortfall for 2017/2018 is an eye-watering R50bn, due to a lack of economic growth and tax collections. On the current trajectory, this number quickly balloons to over R200bn over the coming three years. And while raising income tax is often seen as the quick fix, South Africa may now be approaching the second half of the Laffer Curve, suggesting that higher tax rates may result in lower tax revenue.
The net result is that the budget deficit, which was projected to be 3.1% of GDP, as presented by ex-Finance Minister Pravin Gordhan in February, now appears to touch 4.3% of GDP in the coming fiscal year. That is an incredibly tough pill to swallow, and leaves one to question how things can go so pear-shaped in a matter of seven short months.
The second staggering number presented by Gigaba was Treasury’s forecasted debt to GDP ratio. Ten years ago this number sat comfortably below 30%. Today, South Africa has a national debt to GDP ratio of a little over 50%. The expectation from Treasury, however, is that by the 2020/21 tax year, the national debt to GDP ratio will sit at a lofty 60%. As a reminder, that is only three years away, and entails debt rising by 20% relative to real GDP growth over this period.
The proceedings in parliament would have been keenly watched by the familiar ratings agencies, along with local and global investors. The patience of the ratings agencies is something to behold. A year ago, the imminent downgrade to “junk” status was just around the corner, and plastered over every newspaper’s front page. Today, newspapers rarely publish an article that suggest S&P, Moody’s or Fitch even exist. Unfortunately, at PCS we believe it is a question of when and not if. However, we also believe that the downgrade is largely priced into our currency and bond market. Both markets did not react favourably to today’s proceedings, but this is largely understood given the short-termism of capital markets. Bad news is typically met with knee-jerk reactions that tend to recover over time.
So where to from here?
Fiscal consolidation, as laid out by Pravin Gordhan, seems to be a thing of the past with the apparent acknowledgement that Treasury lacks the firepower to take the necessary tough decisions. It is also becoming clearer that expenditure cuts here and there, coupled with tax hikes will do little to improve the budget. Perhaps even having the reverse effect. Talking and arm waving no longer cuts it.
One thing Gigaba is getting right is that he has recognised the perilous situation South Africa finds itself in. And whether he believes it or not, the only obvious way out is through economic growth. South Africa desperately needs to set itself on a new path, and escape the low growth trap that we find ourselves in.
How do we do this? Do not look to the Medium-Term Budget Speech to find the answer, because it is not there. Gigaba is betting an economic turnaround on the back of successful turnarounds at state-owned enterprises such as the Post Office, Eskom and South African Airways. He believes the successful turnaround of such entities will restore confidence from the private sector. His beliefs hold merit, but at the same time, they are fundamentally flawed.
A very quick win for South Africa would come in the form of renewed business confidence, from both local and global businesses, which would quickly feed through to the consumer. However, reigniting confidence in South Africa will not come from the Post Office, Eskom or South African Airways. Most importantly, a quick win comes in the form of political certainty. Sending the right message out, including a relook at the proposed Mining Charter, and clarity around land reform would go a long way in building business confidence. Looking further ahead, confidence comes from a number of structural reforms, which we are all too familiar with.
From an investment perspective, local South African equity investors reaped the benefits of the lacklustre Medium-Term Budget Speech. Although negative for South Africa Incorporated and the rand, the local equity market jumped on the news as rand-hedge counters did the heavy lifting. While it may seem perverse, this reaction highlights the fact that we live in a global world with the majority of the local market deriving earnings from abroad. If anything, the Medium-Term Budget Speech highlighted that we are all global investors, whether we believe it or not.