Fitch expresses concerns over SA budget

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Fitch expresses concerns over SA budget

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JIMMY MOYAHA: You are listening to the SAfm Market Update With Moneyweb. I’m your host, Jimmy Moyaha, and we’re taking a look at the latest developments from the rating agency Fitch. They’ve announced that they’re not too confident in the budget speech that was delivered by Finance Minister Enoch Godongwana last week. They flagged some concerns – and these concerns are shared by Foord Asset Management.

I’m joined on the line by Linda Eedes, an investment executive at Foord Asset Management, to take a look at this. Good evening, Linda. Thanks so much for taking the time.

Let’s start with the areas of concern that Fitch flagged in their statement. We know they gave us a ratings review in January, and they held the outlook at stable. But there were some concerns there. Following the speech that was delivered last week, they came out again yesterday, I believe, with some revision of those concerns.

LINDA EEDES: Good evening, Jimmy, and thanks for having me. Yes, absolutely, they did and, as you say, we do share some of those concerns.

They first of all affirmed their credit rating of BB-, so we still remain in junk status.

And they said that they regard the budget as being a bit too optimistic in various regards.

The first thing was in terms of projections for revenue. They think that the shortfall between what the government earns and what it spends could actually be better than the budget has projected.

And then second of all, they’re worried that the budget didn’t make any further provision for more state-owned enterprise [SOE] bailouts. So of course we saw Transnet being given a government guarantee of R47 billion in December, but they actually think that this could increase – and:

They’re projecting that Transnet will require another R50 billion in the next two years.

And then the last point they made, which we share, is that using the unrealised gains in the Gold and Foreign Exchange Contingency Reserve Account [GFECRA] did bring down the amount that they need to borrow, but it basically just kicks the can down the road. It doesn’t solve underlying issues which are being driven, such as credit rating.

Read: Treasury taps into R500bn contingency reserve account

Those are the things that they outlined as being a little worrisome.

So a sensible budget – but is it very realistic?

JIMMY MOYAHA: Let’s dig into some of the SOE concerns there. Let’s start with that. Obviously the revenue side of it and the optimism around the revenues are not much we can look at until we start to see revenue collections from Sars. I remember catching up with Edward Kieswetter of Sars around that, and he said that Sars will continue to work hard to collect as much as it can, but it’s difficult for it to commit to a number.

But I want to look at the SOE side of it. Before we get into the Gold and Foreign Exchange Contingency Reserve Account, [among] the SOEs obviously the main concerns there are Transnet, but also Eskom. If I remember correctly, just before the budget speech or leading up to the budget speech, the Eskom diesel budget expected for the whole year was almost completely maxed out. I think we still had three or four months left for the financial year, so that means that Eskom is spending more than it budgeted for, and someone has to pick up that shortfall.

Is this something that you are also flagging from your perspective, to say that SOEs were completely ignored and Eskom and the likes of the Post Bank are in dire need of assistance – and somewhere down the line it’s going to come back to bite us?

LINDA EEDES: Well, Jimmy, as we know, the main reason South Africa’s economic growth has been constrained has been problems with regard to energy supply and obviously the deterioration in our infrastructure. There, of course, we include the railways and the ports.

Of course, these problems do need to be fixed. But unfortunately just providing SOE bailouts – and this has been the case with Eskom – doesn’t seem to have been fixing the underlying problem. So those are the things that Fitch would look at in terms of South Africa’s potential.

Why that matters is because they sort of set a gauge as to how the world regards South Africa in terms of riskiness – both to lend government money to, and also in terms of the return that investors require in terms of investing in South Africa.

So yes, absolutely, we think that it’s unrealistic to not have made provisions for this, although of course we need to see that spend being implemented effectively – and that’s something that the SOEs don’t have a very good track record with.

We need to see economic reforms. We need those infrastructure issues solved. Those problems need to be solved. South Africa’s growth rate has been less than 1% on average since 2012, and our population is growing faster than that. So on a per-person basis we are getting poorer.

Then the other thing that Fitch looks at in terms of all of this, where they are sort of saying the government may need to take over another R50 billion of Transnet’s R150 billion debt – why that matters is because government’s debt levels are already incredibly high. Government [debt] is sitting at over R5 trillion and that seems to be escalating, and in an election year, spending is difficult to rein in.

And, of course, the interest rates that we are paying on that government debt are really eating into our budget. So 21 cents of every rand that the government collects in revenue and taxes and the like is just spent on paying the interest on our government debt.

The likes of Fitch will actually give an indication to the world as to how high that interest rate needs to be in order to compensate those who lend to the South African government for the risk they are taking.

And unfortunately it just seems that the South African government has become an increasingly risky proposition over time.

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So that [spending] really needs to be reined in; government debt levels do need to be brought down and, importantly, the world needs to see us as a less risky country to lend money to – so that those interest levels go down and we can spend in other more important areas of the economy in order to encourage economic reform.

JIMMY MOYAHA: If we’re trying to be a less risky country to the outside world for foreign direct investment, is tapping into the Gold and Foreign Exchange Contingency Reserve Account a good idea? I know other countries do it all the time and it’s not an uncommon exercise for a government to embark on this, but is it smart for us to use that to tackle our debt, or is there an alternative we should have explored – perhaps trimming down the public sector wage bill or dealing with our underlying fiscal problems? Is there something else we could have done as opposed to dipping into this account?

LINDA EEDES: Yes, Jimmy, absolutely. I think all of the things that you’ve mentioned are issues for us. The public sector wage bill continues to be bloated. Of course we’ve seen above-inflation increases over the years, and those are unsustainable. But I think it probably was realistic to see that being brought back considerably in an election year.

It is a short-term fix. I think had they not done that, the markets would’ve reacted quite negatively.

But as I say, it’s really just a short-term solution. It doesn’t solve the underlying problem, which is creating an environment that is able to grow. Our economy needs to grow sustainably to be able to service and bring down our debt.

One of the things that as investment managers we look at is the debt-to-GDP ratio – so the total amount of government debt relative to the economic output of the entire country, so all the goods and services that South Africa produces in the form of its GDP.

Now that ratio has gone from around 30% more than a decade ago to over 70%, and is projected to go to around 75%. That has been brought down slightly by using some of those unrealised gains, which is an important thing.

But Fitch and Foord Asset Management think that that debt-to-GDP ratio is going to start increasing again, and is probably going to be worse than the budget is expecting.

We think that it might be over 80% – and then you’re getting into really tricky circumstances in terms of having enough goods and services produced by your economy to sustainably service the amount of debt that it needs.

Those are the key metrics that we’ll be looking at going forward.

JIMMY MOYAHA: Linda, National Treasury in the budget speech outlined a growth forecast of 1.6% for the medium term over the next three years or so; averaging at 1.6%. First of all, is that a realistic number by your estimates and expectations? And secondly, what is a realistic number if that isn’t?

LINDA EEDES: Again, we think that might be a little overly optimistic. Obviously a lot also depends on the global economy, but it’s probably likely to be closer to 1%. Again, we think that the assumptions made may be a little more optimistic than is likely to be the case.

In particular, of course, we just need these major problems solved – and unfortunately the SOEs and government in terms of actual execution have not demonstrated the ability to do that very rapidly.

But let’s hope that we’ll be surprised on the upside rather than the downside in that respect.

JIMMY MOYAHA: We always hope we’re pleasantly surprised, but we are also alive to the fact that we deal with a lot of challenges.

Linda, before I let you go, I want to look at some rumblings that we’ve been hearing around the central bank potentially wanting to explore – and this has been an ongoing conversation for many, many years now – the opportunity or the prospect of revising down the inflation-targeting band from 3% to 6%, to 2% to 4%.

With the current economic conditions that’s going to prove very difficult to do, leaving interest rates higher for longer. Is this something that you think should be done, or do you think we should be focusing on economic growth, stimulating the economy, creating jobs, and then we can deal with this later?

LINDA EEDES: Well, again, one of the things that we look at is the likelihood that the government is able to bring inflation down to those levels? We have obviously seen inflation drifting just a little lower over time. More recently it has had a bit of an uptick. A lot of the inflation is obviously imported into our economy.

Unfortunately, one of the things we don’t have is economic growth that actually creates inflation, so in contrast to the likes of the US – where some of that inflation in the core side has actually been because the economy has been more resilient than expected. You can’t really sustainably see inflation drifting down unless you solve many of the issues which face us.

So in terms of bringing it down to a lower level again, we would like to see inflation remaining within the current band. Some of that is outside the control of the monetary authority. That is something we will see in terms of how that actually plays out.

JIMMY MOYAHA: Well, we’ll keep an eye on it, see how everything plays out. Hopefully, we have more positive conversations around these and other topics as we go forward, and hopefully, we do see the fiscal reform that we so desperately need to reassure international investors, but also to grow our own economy.

Thanks so much, Linda. We’ll leave it at that. That was Linda Eedes, an investment executive at Foord Asset Management, joining me to take a look at the latest announcements from Fitch, expressing concerns over the budget speech expectations that were delivered last week.

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