South Africa’s Debt Challenge Remains Despite Stronger Revenues – Fitch
South Africa’s budget for the fiscal year ending March 2022 (FY21/22) reflects an improvement in the fiscal trajectory relative to Fitch Ratings’ earlier forecasts, but severe challenges to the government’s ability to implement consolidation persist, says Fitch. Government debt will continue to rise in the medium term, posing downside risks that are reflected in the Negative Outlook on the sovereign’s ‘BB-’ rating.
The government’s consolidated fiscal deficit projection in FY20/21, at 14% of GDP, is slightly smaller than the 15.7% it had projected in the October Medium-Term Budget Policy Statement. The better performance in FY20/21 partly reflects higher-than-expected revenues, which the government projects will exceed its October forecasts by around ZAR100 billion (2% of GDP). Fiscal inflows have been boosted partly by the rebound in mining commodity prices and a stronger-than-expected recovery in domestic demand.
Spending in FY20/21 will be around ZAR38 billion (0.8% of GDP) lower than we had expected when we downgraded the rating from ‘BB’ in November 2020. This follows a court decision in December ruling that the government did not have to adhere to a previous three-year wage agreement with public-sector labour unions. An appeal by unions to the Constitutional Court over this verdict is still pending.
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Given the stronger starting point, the government has improved its projections for the fiscal deficit through FY23/24 by around 1% of GDP per year and now targets to stabilise gross government debt at 89% of GDP by FY25/26 versus an earlier target of 95% of GDP. Under the medium-term expenditure framework, the authorities aim for 8.6% of GDP improvement in the consolidated primary deficit between FY20/21 and FY23/24, the bulk of which will come from the phasing out of pandemic-related spending and a lower wage bill. They expect to achieve a primary surplus in FY24/25.
The government plans to cut non-interest expenditure by around 2% of GDP relative to pre-pandemic levels, half of which will come from lower payroll spending. We continue to believe that cuts of this scale will be difficult to achieve and maintain more conservative assumptions than the government about the pace of fiscal consolidation.
Around 1% (in GDP terms) of the improvement in the primary balance will be achieved through a gradual recovery in revenue receipts post-pandemic, but the government has withdrawn plans for a minor three-year tax package, worth ZAR40bn over the full period, that it had announced in the June supplementary budget.
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Curbing wage growth remains core to the government’s medium-term fiscal consolidation plan, but will be politically challenging. The smaller-than-expected fiscal deficit in FY20/21 may give unions leverage to pressure the government to soften its position on wages. The political calendar will also weaken the government’s negotiating position. Local elections are due later in 2021 and tensions with its union allies could undermine the ruling ANC party’s performance at the polls. Ongoing conflicts within the ANC, notably over governance issues, are now at a crucial juncture and could also hamper the government’s negotiating position.
The government will face other challenges in meeting its fiscal consolidation goals. Structural bottlenecks continue to hold back medium-term growth prospects, although we forecast GDP growth to rebound to 3.6% in 2021, mostly reflecting base effects and the sharp recovery in mining prices. Weak growth will complicate the authorities’ efforts to reduce the budget deficit while simultaneously attempting to tackle exceptionally high social inequality and elevated unemployment.
Meanwhile, the potential need to extend further financial assistance to troubled state-owned enterprises, including the ailing national electricity company Eskom (B/Negative), presents material downside risks to public finances.
This article was culled from Fitch Ratings.