Tito talks the talk, but can he walk the walk?
Due to the economic damage bought about as a result of the COVID-19 Crisis, Tito Mboweni was forced to announce a supplementary budget to that of his budget delivered in February of this year.
The Finance Minister stood up and announced to the country, that unless we change our ways, we are staring down the barrel of a debt spiral in South Africa. He was at pains to point out that the social compact of the last 26 years would be under enormous stress, if interest and debt repayments start robbing our children of their futures.
He admitted that if the country took a passive approach and did nothing to curtail spending, we would be facing a future of debt-to-GDP ratios of over a 100% and reaching 140% in 2028 (as shown in the graph below).
Left unchecked, the interest payments on that debt will become one of government’s largest expenditure items over the medium term. An ever-increasing share of tax revenue will not go to hospitals, schools or social grants – instead, it will be transferred to bondholders. At current forecasted levels of debt for the year for 2020/2021, interest costs will be 22% of the country’s budget and will only go higher if debt levels are not curtailed.
But in his words, the government has chosen the active route and has plans in place to reduce debt levels so that debt peaks at 87% in 2023/2024 and then starts to fall. It was pleasing to see government talking a good story, saying that the public sector wage bill would have to be cut and that R230 billion of additional cuts would be enacted over the next two years, starting in 2021. Increased taxes of R40 billion over 4 years would also be needed, which will be a lot harder to achieve.
The problem is, do we believe them and for now the jury is out; but I for one am pleased to see them admitting they have a debt problem – for the first step in fixing one’s problem is to admit you have one.
Source: National Treasury & SARS
In the shorter term, what does the supplementary budget mean for our clients’ portfolios and does this budget change our views on asset classes?
Firstly, we need to unpack what was announced yesterday. Mr Mboweni showed some pretty scary numbers on revenue shortfalls, with the tax take now forecast to be R304 billion less than forecast at the beginning of the year. This is as result of the lockdowns and is based on government’s estimates of a decline in GDP this year of over 7%. As is obvious from the graph below this is material and not surprisingly is one of the main reasons our budget deficit is forecast to rise to 14.6% of GDP this year from the previous forecast of 6.8% of GDP.
Increased unforeseen spending due to COVID-19 is also a factor, but the revenue shortfall is the biggest factor behind the ballooning deficit.
In-year revenue compared with Budget forecasts (2020/21 prices)
Source: National Treasury & SARS
This short fall has to be funded and for now the bulk of this increased funding needs will be tapped via short term money market instruments and offshore funding via the IMF COVID-19 Funds and the New Development Bank. This was seen as bullish from the bond market perspective, as there were fears that we would see a large increase in issuance in the bond market and for now that does not appear to be the case. Coupled with inflation falling to 3% recently, we remain bullish on SA bonds, in the 7-10 year part of the curve. We remain cautious on the longer dated part of the bond market, despite the Minister’s pledge to reduce government spending and bring our debt levels under control – as words are just words and we need to see action.
As far as SA domestic equities are concerned, if government sticks to their promises and cuts back on spending there will be short term pain. Government employees have been the largest consumer in the domestic economy, given that they have been granted increases way in excess of inflation for the last couple of years. Longer out, it paves the way for a more sustainable economy, but we could see earnings under pressure as taxes keep rising and salaries are muted for the next couple of years.
In summary, Mr Mboweni admitted that the government had a spending problem, and if left unchecked debt will rise to unsustainable levels and rob our children of their futures. This is not the path that they are planning to choose, but we are facing the prospect of a few years of austerity if government has the political will to enact these spending cuts. This will be music to the ears of bond investors, but not to those companies who have benefited from the gravy train. We remain overweight SA bonds and underweight SA incorporated equities.
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