What to Expect from the South African Medium Term Budget - Whitepaper What to Expect from the South African Medium Term Budget
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Whitepaper
What to Expect from the South African
Medium Term Budget
What to Expect from
the South African
Medium Term Budget
Project Finance | Private Equity | Corporates | Social Infrastructure | Real Estate
Financial Risk Advisors
jcragroup.com
Whitepaper What to Expect from the South African Medium Term Budget Contents Executive summary 1 Economic overview 2 Government debt is above 50% 2 2017 recession and low economic growth 2 Unemployment remains high 3 Finance Ministers: Gigaba and Gordhan 4 How they compare 4 Gigaba: his performance so far 5 Medium term budget policy statement 6 What the economy needs 6 What to expect 7 Conclusions 8
Whitepaper 1 What to Expect from the South African Medium Term Budget Executive summary: For any successful economy, a spirit of mutual respect and teamwork between Government and the private sector must exist. In South Africa, business confidence is at its lowest level since 2009, which, unsurprisingly, coincides with low GDP. With his upcoming mid-term budget announcement, the finance minister has an opportunity to instil confidence in the business community by demonstrating that Government is serious about working with them. He will also need to display his commitment to dealing with State Capture, stamping out corruption and curtailing spending excesses at state-owned enterprises. Furthermore, the minister must convince the market and the ratings agencies that he has Government expenditure under control. He has very few tools available to him to stimulate growth and needs to pay very careful attention to perceptions as the market will be watching closely, with little patience for ambiguity. This paper provides an economic overview and addresses the situation Gigaba currently finds himself in while providing some insight into the outcomes JCRA expect to see from the announcement, and what the South African economy needs to jump-start itself.
2 Whitepaper
What to Expect from the South African Medium Term Budget
The amount of debt the Economic overview 2017 recession and low economic growth
government builds up In the first quarter of 2017, South Africa’s
Government debt is above 50% economy entered a technical recession2, a
has direct consequences blow for the newly appointed Finance Minister,
The ratio of South African government debt to
for business confidence GDP is growing, and is now above 50%: an all- Malusi Gigaba. The news of this recession
and investment levels. time high. However, the International Monetary stimulated the creation of the government’s 14
Fund (IMF) has forecast that it will continue point Inclusive Growth Action Plan in June3. Upon
to grow in the future. The amount of debt the the announcement of this plan, which outlines
government builds up has direct consequences various structural reforms to support both
for business confidence and investment levels. business and consumer confidence, the Finance
Rating agencies have become increasingly Minister promised to more comprehensively
concerned about the government’s ability to raise speak to [the] economic outlook and growth
enough tax revenue to cover spending, and this prospects in the medium-term budget policy
contributed to the sovereign credit rating being statement .
cut to junk status by two agencies earlier in 20171.
While business confidence fell to its lowest level
since 2009 in the second quarter of 2017 as a
result, it has since picked up.
Figure 1: Debt/GDP
60
50
40
30
%
20
10
0
2000 2005 2010 2015 2020
Debt/GDP Debt/GDP forecast
Source: IMF
https://www.ft.com/content/5b8e083c-1b91-11e7-bcac-6d03d067f81f
1
2
A technical recession is defined as two consecutive quarters of GDP contraction
3
National Treasury of South Africa: Government’s Inclusive Growth Action Plan (2017)
Whitepaper 3
What to Expect from the South African Medium Term Budget
Unemployment Figure 2: GDP annual growth
reached 27.7% in the 10
second quarter of 2017, 8
its highest point since 6
2003.
4
2
%
0
2000 2002 2005 2008 2010 2013 2016
-2
-4
-6
-8
GDP growth
Source: Statistics South Africa
Since the release of the action plan, economic Youth unemployment also reached 52% in 2016,
growth has picked up again and South Africa up from 46% in 2008, showing that South African
broke out of its technical recession in the second unemployment is concentrated in the country’s
quarter of 2017, with GDP rising at an annual rate younger population6.
of 2.5%. However, Figure 2 shows that GDP has
The World Bank South Africa Economic Update
been volatile for the past few years, so another
highlights that South Africa is falling behind
bout of negative growth in the coming quarters is
other countries in terms of productivity (which
not unlikely.
declined by 2% during the first quarter of 2017)
The World Bank revised their South African especially in the technology sector. This can be
GDP forecasts up to 2019 in September4. They attributed to a low level of innovation and a loss
now expect GDP to grow 0.6% in 2017, which is of skills caused by professionals moving to other
low compared to the figure of 1.3% the Treasury OECD countries. The World Bank also cited low
estimated in the February budget. The World productivity as a reason for slashing their 2017
Bank expects 1.1% growth in 2018 and 1.7% in 2019 South African growth outlook from 1.1% to 0.6%.
respectively. In contrast, the February budget
forecasts were 2.0% and 2.3% for these years.
Unemployment remains high
Weak GDP growth is underpinned by high levels
of unemployment and subdued productivity.
Unemployment reached 27.7% in the second
quarter of 2017, its highest point since 2003.
Only 16 million people5 - or 28% of South Africa’s
rapidly growing population - were employed in
the second quarter. This low employment figure
reflects the fact that the long term unemployed
often cease trying to gain employment, and
so drop out of the unemployment statistics.
If they were included in those statistics, the
unemployment rate would increase considerably.
World Bank: South Africa Economic Update: Innovation for Productivity and Inclusiveness (2017)
4
Statistics South Africa
5
World Bank, World Development Indicators, youth unemployment
6
4 Whitepaper
What to Expect from the South African Medium Term Budget
Investment in South Finance Ministers: Gigaba and The dismissal of Gordhan by South Africa’s
African long term bonds Gordhan President Jacob Zuma in March resulted in a wave
of credit rating downgrades and a reduction in
has remained healthy business confidence. Fitch downgraded both the
How they compare
and they are still Pravin Gordhan was Finance Minister until the foreign and local currency rating to junk, while
attractive compared to end of March 2017. His infrastructure plan and aim S&P reduced the foreign-currency rating to non-
those of other emerging to limit spending won over investors and calmed investment grade, keeping the local currency rating
economies. However, markets. Prior to his appointment in 2015, the rand at investment grade. Around 64% of government
was at an all-time low, but it gradually recovered bonds were owned by domestic investors in 201610,
yields remain high
during his appointment as Minister. Gordhan meaning that the local-currency rating is more
compared to the time significant for the majority of investors. However,
prioritised infrastructure spending in his 2017
when Gordhan was budget, allocating R195.8 billion for infrastructure the share of foreign investors increased between
minister, reflecting the and local development in the 2017/2018 financial 2015 and 2016 from 32.4% to 36.0%11. Moody’s also
higher perceived risk. year. downgraded South African government bonds in
June, but both foreign and local currency-ratings
Gordhan also had a strong anti-corruption stance remained at investment grade.
that helped build trust and confidence. There have
been corruption charges against the new Finance Despite the initial strong response (rating
Minister, Malusi Gigaba since his appointment, downgrades and bond disinvestment) to the
especially relating to his relationship with the appointment of Gigaba, bond yields and the
Guptas7; however so far none of these have rand have stabilised since, and Gigaba quickly
resulted in charges8. announced his commitment to Gordhan’s
February budget. Investment in South African
In Gordhan’s February budget, he estimated that long term bonds has remained healthy and they
the spending for this financial year will be R1.56 are still attractive compared to those of other
trillion, and that tax revenue will be R1.41 trillion, emerging economies. However, yields remain high
with a budget deficit of R149 billion9. One of the compared to the time when Gordhan was minister,
most important tests for the new Finance Minister reflecting the higher perceived risk.
will be sticking to this budget, especially by
keeping spending down.
Figure 3: Government bond credit rating relative to junk (August 2017)
1
Level relative to junk
0
-1
Fitch Standard & Poor's Moody's
Foreign-Currency Rating Domestic-Currency Rating
Source: Bloomberg, Fitch, S&P, Moody’s
7
A wealthy business family in South Africa whose strong ties to President Jacob Zuma have led to claims of corruption, undue
influence and of state capture
8
https://qz.com/1002519/south-african-finance-minister-malusi-gigaba-faces-corruption-allegations-over-gupta-family-
connections/
9
South Africa National Treasury: Budget Review 2017
10
South Africa National Treasury: Budget Review 2017
11
South Africa National Treasury: Budget Review 2017Whitepaper 5
What to Expect from the South African Medium Term Budget
Eskom poses a Gigaba: his performance so far Reports also speculate that the Treasury might sell
particular risk to the The biggest challenge for current Minister its 39% stake in landline provider Telkom to fund
of Finance, Gigaba so far has been limiting the SAA bailout. Gigaba told parliament in early
economy, with government expenditure and preventing fiscal August that they would not be selling the Telkom
requirements for R413 slippage (deviations from what was promised in stake to fund bailouts. Therefore, if he chooses
billion in interest and the 2017 budget). If the level of spending exceeds to go back on his word on this matter market
debt payments over the tax revenues by too much, then the risk of public confidence in Gigaba is likely to weaken.
next five years. debt distress will increase, which is likely to fuel
Since his appointment, Gigaba has also spoken
further rating downgrades.
about the importance of raising employment
In July, the South African government paid R2.3 in South Africa, which at present creates a large
billion to South African Airlines (SAA) in order for restraint on economic growth. The 14 point
them to settle a loan from Standard Chartered. Inclusive Growth Action Plan released in July aims
On 29 September, they were permitted another to create complementary government funds
R3 billion to repay a Citibank loan. In addition, aimed at financing SMMEs (small, medium and
SAA have asked the government for R13 billion in micro enterprises) in their start-up phase which
order to recapitalise12, which Gigaba is expected to may aid employment increases.
address in the upcoming medium term budget.
However, he is facing increasing pressure to come
up with the funds that have already been given
to SAA and so further spending on SAA is likely to
prove unpopular.
Gigaba also has to manage the government’s
contingent liabilities (commitments to take
responsibility for state owned enterprise (SOE)
loans in the event of a default), of which Eskom,
independent power producers and the Road
Accident Fund make up the majority. Eskom
poses a particular risk to the economy, with
requirements for R413 billion in interest and debt
payments over the next five years13. They also face
corruption allegations relating to the Gupta family.
Gigaba has given limited information to the
public so far in describing how he will raise the
funds for the government to cover the pay-outs to
SOEs. There have been reports that the Treasury
may request the Public Investment Corporation
(PIC, manager of the Government Employees
Pension Fund) to buy the government’s R12
billion stake in Telkom (a wireline and wireless
telecommunications provider) to fund some of
the SAA bailout. PIC has about R1.86 trillion in
assets, and is one of the country’s best performing
companies. However, Gigaba has stressed that no
formal or informal request has been made to PIC.
Gordhan has also criticised the idea of using PIC
funds to bail out SOEs, suggesting that they need
to correct the cause of the financial distress before
handing over more money14.
12
https://www.reuters.com/article/us-safrica-economy/south-africa-considering-1-billion-bailout-for-national-airline-idUSKB-
N1AK0UU
13
https://www.bloomberg.com/news/articles/2017-09-22/goldman-sachs-sees-eskom-as-biggest-risk-to-s-african-economy
14
http://ewn.co.za/2017/09/26/gordhan-soes-must-clear-out-rot-before-requesting-bailouts6 Whitepaper
What to Expect from the South African Medium Term Budget
Competition is low in Medium term budget policy statement
South Africa which
means that demand for What the economy needs
Although the economy has emerged from
capital and labour are
recession, the annual growth rate for 2017 is
below their potential, expected to be low, due to weak productivity
and living costs for the and employment as well as drought, electricity
poor are higher than shortages and logistical constraints and Gigaba
necessary, perpetuating needs to address these concerns, while keeping in
the poverty problem. mind that possible spending is constrained by the
size of the economy’s debt.
The World Bank have published a report15 outlining
ways for the South African government to improve
the economic outlook. The report highlights that
productivity needs to increase, which can be
done through innovation. This can create new
opportunities for employment and economic
growth. Policy uncertainty, red tape (excessive
regulation) and limited competition in key product
markets restrain the entry and growth of small
firms. Therefore, if Gigaba addresses these issues
by engaging with businesses and reducing
bureaucracy as well as promoting research
and development, he can create more potential
for economic growth. South Africa already has
clusters of innovation in a few of the largest cities,
but these advancements need to be spread to
other regions.
Another issue Gigaba needs to address is
economic competition. Competition is low in
South Africa which means that demand for capital
and labour are below their potential, and living
costs for the poor are higher than necessary,
perpetuating the poverty problem. Competition
can also stimulate innovation, and thus further
create economic growth.
The National Development Plan16, says that
infrastructure investment as a fraction of GDP
needs to grow to 30% by 2030 in order to reach
a sustained and inclusive growth path. In the
February 2017 budget, Gordhan proposed a new
facility to finance large infrastructure projects
which requires funding or other state support,
such as sovereign guarantees. Although this may
require significant government investment, if
Gigaba implements this plan, it will stimulate
productivity and growth increases which will
benefit the economy.
15
World Bank: South Africa Economic Update: Innovation for Productivity and Inclusiveness (2017)
16
Republic of South Africa: National Development Plan 2030 (2012)
17
https://www.businesslive.co.za/bd/economy/2017-08-21-downgrade-alarm-as-revenue-shortfall-could-hit-r50bn/Whitepaper 7
What to Expect from the South African Medium Term Budget
If the budget What to expect In February, President Zuma announced his plan
announcement does not In terms of spending, Gigaba is in a difficult for a radical economic transformation. Some of
position. If he raises too little tax revenue, there is his main concerns are the persistent economic
satisfy rating agencies,
likely to be another round of rating downgrades, inequality and the underrepresentation of black
we can expect further since rating agencies are concerned by the risk South Africans at top management levels. Gigaba
downgrades of domestic of public debt distress. This is a likely scenario is likely to address the ongoing high level of
and foreign-currency since revenue collection is already substantially inequality in the medium term budget, and will
bonds. This is likely to below budget, with some economists suggesting feel pressure to allocate funds towards achieving
cause the rand to a shortfall for the year of as much as R50 billion17. higher equality, due to Zuma’s promise to "utilise
Another credit rating downgrade could result in a to the maximum, the strategic levers that are
depreciate against the reduction in investors’ appetite for South African available to the state"19.
dollar, as was the case government bonds. A reduction in investment will
after previous rating In light of the World Bank’s growth outlook
slow economic growth, which makes it harder
reduction for 2017 to 0.6%, there is a strong
downgrades. for the government to raise tax revenue (because
likelihood that Gigaba will cut his forecast to
people are earning and spending less). Therefore,
a similar level. Indeed, at the Tax Indaba on 11
a vicious circle may emerge, and Gigaba should do
September, he said that the 1.3% growth forecast
his best to avoid it.
provided in the February budget was unlikely to be
Gigaba needs to reassure investors that realised in 2017. It would be best to accompany a
government spending is being limited to a reduction of growth expectations with an update
minimum in order to avoid a downgrade. Although, on methods of increasing growth in the future, but
the large SOE contingent liabilities make this this will be difficult to do given the importance of
difficult. keeping spending low.
In the medium term budget policy statement he
will also have to address questions on how he will
cover the cost of the SAA bailout and which assets
he has identified for sale. If he decides to sell
Telkom shares then he will have to provide strong
reasoning for this, since he has previously stated
that he wouldn’t do so.
Many are expecting rating downgrades to come.
Despite strong expectations that the central bank
would reduce the base rate to stimulate growth on
21 September, they chose to keep rates steady. The
South African Reserve Bank cited the possibility
of rating downgrades in the near term as a cause
of concern, since they could pose a danger to the
rand18.
If the budget announcement does not satisfy
rating agencies, we can expect further downgrades
of domestic and foreign-currency bonds. This
is likely to cause the rand to depreciate against
the dollar, as was the case after previous rating
downgrades. Furthermore, the central bank may
feel the need to raise interest rates again, since
a depreciation means that imports will be more
expensive, and so could trigger inflation. However,
increasing the base rate again may limit economic
growth.
18
MPC Statement September 21, 2017
19
http://www.sanews.gov.za/south-africa/president-announces-radical-economic-transformation8 Whitepaper
What to Expect from the South African Medium Term Budget
In a volatile and Conclusion
uncertain economic A poor mid-term budget carries the potential for
environment, hedging increased volatility in respect of the Rand and the
can help to mitigate forward rates curve. It will almost certainly set the
market risk and provide scene for further downgrades in ratings and may
confidence in the result in substantial portfolio outflows, putting the
Rand under pressure and negatively influencing
budgetary process by the trajectory of JIBAR and swap rates.
ensuring that future
These risks together with the Fed balance sheet
cash flows are not
unwind, ECB tapering, rating agency decisions,
subject to wild and Nersa’s opining on Eskom’s request for ever
fluctuations. higher tariffs, resulted in the MPC, against market
expectations, deciding to hold off on the next rate
cut pending more clarity. Eskom’s balance sheet
and refinancing needs are also posing significant
negative risks to the economy, as is the ANC
elective conference.
In light of all this, it would be prudent to
consider hedging for both currency and interest
rate exposure and explore the services of an
independent hedging advisor to assist you in
choosing a strategy that works for you at the
best possible price. In a volatile and uncertain
economic environment, hedging can help to
mitigate market risk and provide confidence in the
budgetary process by ensuring that future cash
flows are not subject to wild fluctuations.
JCRA has over 28 years of experience advising on
market risks to corporates, project companies,
funds and the property sector. We are a global
business with significant experience in markets
around the world including South Africa where
we, together with key staff, have been involved
in driving bespoke hedging solutions to large
corporate and infrastructure deals since 2004.
Please get in touch if you would like to learn more
about services we provide and what we can do to
help keep your organisation one step ahead.Whitepaper 9
What to Expect from the South African Medium Term Budget
About JCRA About Cebr
JCRA are independent financial risk advisors with Centre for Economics and Business research
over 25 years’ experience in providing tailored (Cebr) is an independent consultancy with a
hedging solutions for large-scale infrastructure reputation for sound business advice based on
projects. We create transparency by thorough and insightful research. Since 1992,
benchmarking pricing and managing the hedge Cebr has been at the forefront of business and
execution process so that our clients understand public interest research. They provide analysis,
the true cost of their project. forecasts and strategic advice to major UK and
multinational companies, financial institutions,
Carrying a number of mandates for infrastructure
government departments and agencies and
and renewable energy clients in South Africa and
trade bodies.
sub-Saharan Africa, our current projects total
ZAR 18 billion, and we are now targeting a further For further information about Cebr please visit
ZAR 24 billion. With a global reach and experience www.cebr.com
advising on projects across the UK, Europe, North
America, Australasia and Africa, the JCRA team
have the expertise to help you and your project
stay one-step ahead.
jcragroup.com
For more information, or to discuss this
whitepaper, please contact:
Lionel Kruger, Ian MacFarlane,
Director, sub-Saharan Africa Director, Project Finance
T: +44 (0)207 493 3310 T: +44 (0)207 493 3310
E: lionel.kruger@jcrauk.com E: ian.macfarlane@jcrauk.com
This whitepaper is fifth in a series,
previous whitepapers can be downloaded @ jcragroup.com
Issue 1 Issue 2 Issue 3 Issue 4 Issue 510 Whitepaper
What to Expect from the South African Medium Term Budget
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