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Has enough been done to prevent a Moody’s downgrade?

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 Moody's PHOTO:
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Since 2012, South Africa’s national budget has been in sharp focus due to repeated sovereign credit downgrades and rising awareness of state dysfunction and widespread public sector malfeasance.

Moreover, despite the recent leadership changes at the helm of both the governing party and the state, South Africa’s fiscal position is precariously balanced. It is only Moody’s Investors Service of the major rating agencies that still gives South Africa investment grade status.

The 2019 budget speech is particularly important for two more reasons: it occurs on the eve of perhaps the most significant national elections since 1994, and it includes one part of the proposed and enormously costly turnaround of Eskom, which may impair the sovereign’s standing, especially through the Moody’s lens.

A downgrade by Moody’s would not only remove SA’s only remaining investment grade credit rating, but also trigger the expulsion of SA government bonds from the World Government Bond Index – which would in turn trigger significant capital outflows.

This would probably cast a pall on the ANC’s electoral prospects, given that incumbent government performance and mounting expectations for a growth revival, especially after the notable governance improvements that defined 2018, are right at the forefront now.

Government has made laudable progress in addressing the key culprits of SA’s fiscal deterioration since the global financial crisis.

Without supporting Eskom, government’s budget deficit would have improved, while the debt trajectory would have eased.

Instead, after R69 billion earmarked for Eskom over the next three years, the main budget deficit increases to R255 billion (4.7% of GDP) in 2019 and debt rises to a peak of 60.2% of GDP (around 2 percentage points higher than before).

Unfortunately, Eskom hasn’t been the only one-off shock to government’s budget – last year there was the sudden introduction of fee-free tertiary education, and government began to repay its sizeable overdue value added tax (VAT) refunds.

This might not be the last such “one-off” big adjustment either: the National Health Insurance is not yet fully budgeted for, there are significant arrears at municipal and provincial government levels and we remain cautious about the forecast risks around the fee-free tertiary education costs (given the unknown income distribution of prospective students and uptake of this grant).

The recurring theme, however, is that government’s fiscal decisions have turned the corner. The decay has not only been arrested, but is gradually being reversed.

Nevertheless, there are numerous legacy problems that have had or could have a marked negative impact on government’s budget.

Everyone will have to pay the price of the historical mistakes.

In previous budgets, the VAT rate, estate duty, personal income tax, fuel levies and capital gains tax were raised.

This budget squarely apportions the cost to individuals – with a R12.9 billion increase in their tax burden – by not adjusting tax brackets for inflation. The portion of income that individuals spend on their personal income tax is the highest in two decades, after rising by around five percentage points over the past 15 years.

This at a time when there are ample signs that consumers, apart from the higher-income groups, are under pressure.

This adds to consumer headwinds, and aggravates downside risk to our 1.3% economic growth forecast for 2019.

In addition to this year’s nearly R15 billion in tax hikes, a further R10 billion is pencilled in for next year.

These should be the last hikes in the series that began at least five years ago, with government hopeful that efforts to improve tax administration and reduce tax evasion will start to pay off.

Even conservative estimates of the impact that this would have on tax revenues imply that this could already start to reverse the rise in government’s debt trajectory.

The same can be said for the probable impact of clamping down on corruption.

However, it is unclear if enough has been done to prevent negative rating action by Moody’s.

Our analysis of the agency’s rating methodology implies that the Moody’s quantitative assessment should still support an unchanged rating for South Africa despite the fiscal slippage.

However, there is ample scope for Moody’s to make subjective adjustments in its rating assessment, which may justify negative rating action.

In short, the 2019 budget increased the risk that Moody’s may ultimately downgrade South Africa’s sovereign credit ratings.

Financial markets and the rand will be most wary ahead of the Moody’s rating review to be released on March 29.

Right now we still foresee no rating action, but the risks are material.

If we are right, the rand should ultimately strengthen and bond yields compress, given our expectation for constructive political and policy developments later this year.

  •  Moolman is head of SA economic and markets research at Standard Bank
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