On Wednesday afternoon, our newly appointed Finance Minister Enoch Godongwana delivered the National Budget for 2022, highlighting the state of the economy, public finances, and fund commitments.
The national treasury is making allocations of R17.5bn for infrastructure, small and medium-sized enterprises are allocated a total support package of R20bn in the form of loan guarantees backed by government and equity-linked guarantees, and R76bn is allocated to job creation programs. National Treasury also announced R5.2bn in tax relief, personal income tax brackets and rebates are adjusted in line with inflation, corporate income tax is reduced by 1% to 27%, excise duties for alcohol and tobacco will increase by 4.5-6.5% and there was even a mention on the possible introduction of a vaping tax and a tax on beer powders.
The Finance Minister announced that the budget deficit will narrow to 5.7% from the 7.8% forecasted at the 2021 MTBPS, and he forecasts a primary budget surplus of R3.2bn in 2023/2024. Real GDP growth is projected at 2.1% for 2022 and is forecasted to average 1.8% over the next three years. In recent years, South Africa has been stuck in a growth trap, struggling to achieve growth above 1.5% per annum.
While the forecasts from the National Treasury signal that some progress is being made in terms of economic reforms, the reaction to the budget speech was muted, and USDZAR weakened slightly by 5cents by close of trading. We believe this is because the reforms are not happening at a fast enough pace to prevent South Africa falling into a debt trap, considering how dire the economic situation has become.
A little push and everything could fall apart. South Africa has uncomfortably high debt service costs – R268bn for the 2021/2022 financial year, increasing to R301bn in 2022/2023, and R335bn in 2023/2024. Total export earnings of R201bn would be required to achieve a relatively modest debt service coverage ratio of 0.75, yet even during the 2021 commodity boom, South Africa’s total exports earnings were only about R156.3bn. Although the finance minister sees a primary surplus of R3.2bn in 2023/2024, we remain perilously close to the edge. We find ourselves wondering if the pace of economic reforms is fast enough to encourage global rating agencies to revise our sovereign debt rating from “junk” status.
Debt Service Coverage Ratio Analysis
Sources: Prowess Investments, Trading economics and National Treasury.
A huge portion of South Africa’s tax revenue is required to cover debt servicing costs and the public sector wage bill at the expense of capital investment. Between 2010-2020, public sector investment averaged 5.8% of GDP while private-sector investment averaged 11.2%. In 2020, combined capital investment by the public and private sectors was 13.7% of GDP, significantly below the National Development Plan (NDP) target of 30% of GDP designed to reduce unemployment and poverty.
In 2022, public-sector infrastructure spending in the Medium-Term Expenditure Framework (MTEF) is forecast to be R821.5bn. We believe this will be too low to make significant strides and we question whether the trajectory of growth in public sector infrastructure spending is sustainable and government’s ability to keep the public sector wage bill contained. National treasury hopes to dial back public service wage bill growth at 1.8% over the next two years. However, the Ministry of Finance doesn’t yet have an agreement in place to solidify this estimate, which is itself based on very conservative assumptions relative to the actual wage growth experienced over the last few years.
South Africa now pays grants to 46% of its population. In 2021, unemployment under the expanded definition was at a shocking 46.6%. There is a growing need for a Basic Income Grant (BIG) to provide relief to those severely impacted by poverty and high unemployment.
The state of our fiscus is uncomfortable with insufficient breathing room. National Treasury is still considering proposals for an introduction of a BIG. Our Finance Minister correctly stated that a permanent grant program could not be funded by the temporary revenue overrun, and the R350 social distress grant is temporarily extended to provide some assistance. In the meantime, the nation is relying on the inherent resilience South Africans to navigate through inequality, unemployment, and devastating levels of poverty. For the BIG to become permanent, other expenses will have to be curtailed. The question remains, where do we trim and how to we justify creating a society that is so state reliant?
Given the state of our fiscus, we believe it likely that the National Treasury will be forced to issue more debt, though the minister described that solution as “unfavourable” at the MTBPS. There are still talks in the market about the likelihood of the issuance of the rand-denominated Islamic bond, though the timing of this is uncertain. The Sukuk bonds were last seen in 2014 when South Africa became the first African nation to issue a sovereign sharia-compliant bond. At the time the $500million Sukuk bond issuance was oversubscribed receiving subscriptions worth $2.2bn. It is likely that there is still an appetite for such an instrument, and the offer would diversify government’s debt portfolio.
The upside to being so close to the edge is that it forces conversations and actions that would otherwise not be happening. We are encouraged by the progress made with reforms and the changes that have taken place in governance. We are also hopeful that the nation’s spirit of ubuntu will continue to prevail and help to steer us to less murky waters!