Last week Malusi Gigaba, then still Finance Minister, delivered a balanced budget, signalling a return to fiscal consolidation. The Budget targets a debt-to-GDP ratio of 56.2% by 2021, which represents a significant reduction in the debt-to-GDP ratio targeted in the Medium Term Budget Policy Statement last October.
Johann Els, Head of Economic Research at Old Mutual Investment Group, views this as an encouraging sign that the new administration is willing to make the tough decisions needed to avoid a further downgrade.
According to Els, the most significant outcome of the Budget was the hike in VAT from 14% to 15%, the first VAT increase since 1993. “While this must have been a tough decision to make, particularly with next year being an election year, we believe it was necessary to raise the revenue required. Understandably, concerns have been raised around the impact this will have on consumers, but it is important to keep in mind that 38% of the CPI basket is not subject to VAT. What’s more, food inflation is expected to decrease, and discussions are also now being tabled to increase the list of products that are VAT exempt.” The impact on the consumer will be further reduced by the positive impact of the strong rand, low inflation and expected rate cuts by the Reserve Bank.
From an investment perspective, John Orford, Portfolio Manager at Old Mutual Investment Group’s MacroSolutions boutique, says that the markets’ reaction to the Budget Speech has been positive overall. “Bond yields have already fallen and the rand has strengthened, reflecting a positive reception of the Budget. We can also expect future flows into the local bond and equity markets as markets price in a smaller probability that South Africa will be further downgraded by Moody’s.”
However, Orford notes that as foreign direct investment (FDI) flows are long-term investments, they are affected by the longer-term outlook and the relative productivity of South Africa compared to alternative investment destinations. “As such, to have a meaningful impact on these flows (FDI versus portfolio investments), we will need to see some implementation of measures to improve policy certainty.”
A good example of this, says Orford, would be a successful renegotiation of the mining charter in a way that addresses mining companies’ concerns. “Should this be accomplished, then it is possible that investment in new mining projects could increase. However, this will take more time and will require delivering a better investment climate.”
Orford adds that, if successfully implemented, reforms of State-Owned Enterprises (SOEs) will also have a significantly positive impact on markets. “Successfully reforming Eskom, for example, would result in reduced contingent liabilities of the government, contributing to a better consolidated fiscal position and credit rating which, all things being equal, would result in a lower cost of debt in South Africa.
“Additionally, a reformed Eskom would result in a more efficient provision of goods and services to South Africa, which would help improve productivity. This, in turn, would contribute positively to raising South Africa’s medium-term growth potential.”
Satisfied with the GDP growth forecast of 1.8% for 2018, Els believes that South Africa may even exceed the expectation and reach a 2% GDP growth rate, if everything goes according to plan. “If we stay on the path outlined in the Budget and implement the necessary SOE reforms, growth of 2% is possible. We do, however, actually need a minimum sustained growth rate of 2.5% for any real impact on our debt-to-GDP ratio and for employment to grow.”
Despite this, Els’s sentiments around the Budget remain positive. “All in all, this was a very good Budget designed to boost confidence in line with President Ramaphosa’s first SONA – a positive start to a long journey to return to investment grade, if we stay on this path of fiscal consolidation and sustainable debt reduction.”
He adds that the Cabinet reshuffle should be very positively received too, particularly the appointments of Nhlanhla Nene at Finance, Pravin Gordhan at Public Enterprises, Gwede Mantashe at Mineral Resources and Jeff Radebe at Energy. “These were the key portfolios where strong people were needed,” he says.